Goldman Sachs raised its short-term S&P 500 target on the back of a more favorable economic picture. But it could drive stocks down by 25%, strategists say.

If there are no more economic surprises, stocks are unlikely to face a short-term collapse and the S&P 500 could return to the 4000 mark.

This is reported by a team of strategists at Goldman Sachs, led by David Kostin. The team raised its three-month target for the SPX index,
-0.50%,
which is up more than 7% this year to 4,000 from 3,600. But Goldman kept its year-end forecast at 4,000, about the middle of Wall Street’s target range of 3,400 to 4,500.

Explaining the short-term optimism in a note to clients late Friday night, Kostin, chief US equities strategist at Goldman Sachs GS,
-0.20%,
said strong US macro data outweighed a so far “underwhelming” fourth-quarter reporting season. Some might say the US data is a bit too firm after Friday’s jobs report, which showed huge job growth of more than half a million, much higher than expected, putting pressure on US stocks again on Monday as the S&P 500 fluctuated by level 4101.

Adding to this positive U.S. economic picture was an earlier-than-expected opening of China and reduced chances of a recession in Europe, the team said, noting that still weak institutional positioning means the market could temporarily beat their bank’s 4,000-point target.

But strategists drew a line under that buoyancy, noting that with a soft economic landing already priced in US stocks, their end-of-year target remains stagnant for now. They noted that the superiority of cyclical over defensive indexes suggests real U.S. economic growth of 2% compared to Goldman’s own below-trend forecast of 1% of GDP in 2023, and the ISM manufacturing index is around 55, compared to a recent reading of 47.

Read: According to this strategist, the next few days could show that investors are rushing for one big rally.

The bank’s baseline EPS guidance is 0% for 2023 and 5% for 2024, compared to the consensus of 1% and 12%, respectively. Strategists said analyst expectations, down 10% since the end of June 2023, are twice the historical pace of negative revisions.

According to Kostin and his team, estimates are also already inflated and will be limited by a possible increase in interest rates. “S&P 500 is trading at 18.4. [times] forward earnings and at an even higher ‘effective’ ratio, given the fact that most investors seem to be expecting earnings well below what analysts are estimating,” they said.

Costin and team said the stock could survive the rise in rates if the move is driven by improved growth expectations. But they don’t see a significant increase in value as Treasury yields continue to rise — they see a nominal yield on 10-year TMUBMUSD10Y bonds.
3.642%
gradually increases to 4.2%.

Also read: How the US dollar could put this stock market rally to the test

With their own base case for the S&P 500 already having limited upside potential, a recession could trigger a “substantial decline” in stocks, they warned. They say the index could fall as much as 25% from current levels, hitting around 3150 in this scenario, driven by lower earnings estimates and a P/E multiple down to 14 times from the current 18.

Another risk is that inflation will continue to slow but fail to meet the Fed’s target, which could lead to monetary tightening and higher interest rates. Finally, they are reminding investors that the U.S. debt ceiling debate, which could kick off later this year, could hurt stocks, as happened in 2011 when the market fell 17%.

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