Are Stocks Set for the Biggest Rally Since '82?

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If Goldman Sachs (NYSE: GS  ) is correct, that is exactly what's in store for us. On Monday, the investment bank raised its end-of-year forecast for the S&P 500 from 940 to 1,060. The new target implies a 15% gain in the second half, which would be the best second-half performance since 1982. That sounds like a strong signal to load up on stocks.

Not so fast
How did Goldman come up with this new target? For one thing, they've raised their earnings estimates for the S&P 500 substantially:




S&P 500 Earnings
(increase over previous estimate)





S&P 500 P/E Ratio, based on closing price on July 21



In other words, Goldman is calling for a 44% rise in profits between this year and the next. Sure, optimism is rising as bellwether companies including JPMorgan Chase (NYSE: JPM  ) , IBM (NYSE: IBM  ) , Intel (NYSE: INTC  ) , Caterpillar (NYSE: CAT  ) , Merck (NYSE: MRK  ) , and Coca-Cola (NYSE: KO  ) beat their estimates for the second quarter. Yes, the first quarter of the year was exceptionally weak, making for easier comparisons next year.

All the same, a recovery in profits of that magnitude over the next 18 months looks aggressive to me. Particularly when one listens to financial economist Andrew Smithers, according to whom, earnings-per-share growth will be shackled by company share offerings necessary to repair balance sheets (all other things equal, more shares means lower earnings per share). "The growth rate of earnings per share is thus likely to be worse than that indicated by profit margins alone," Smithers concluded in a recent note to his clients.

Is the rally over already?
Asset manager GMO, which follows a more serious approach to forecasting than Goldman (they predicted the bursting of the tech and the credit bubbles), expects annual after-inflation returns for U.S. large-cap stocks of just 4.4% over the next seven years as of June 30. While they would be the first to caution investors that making six-month forecasts is a fool's game (thus their own seven-year time frame), their results suggest that the most likely second-half performance for stocks is a 3% increase (at best), for an end-of-year value for the S&P 500 of no more than 947. That's about where the index is currently trading; perhaps the market has already squeezed its second half "rally" into the first three weeks of July.

GMO is forecasting that "high-quality" U.S. stocks will beat large-cap stocks by more than six percentage points annually over the next seven years! Morgan Housel has identified three high-quality companies that are still cheap.

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Alex Dumortier, CFA, has no beneficial interest in any of the companies mentioned in this article. Intel and Coca Cola are Motley Fool Inside Value picks. Coca Cola is a Motley Fool Income Investor selection. Try any of our Foolish newsletters today, free for 30 days. Motley Fool has a disclosure policy.

Read/Post Comments (8) | Recommend This Article (14)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 22, 2009, at 2:34 PM, plange01 wrote:

    you dont get any long lasting rallys in a depression...

  • Report this Comment On July 22, 2009, at 4:28 PM, joaquingrech wrote:

    plange01... unless we are not on a depression :)

    I have no clue where the market will be in 6 months but I hope to know where my stocks will be in 2 years.

  • Report this Comment On July 22, 2009, at 4:32 PM, prose976 wrote:

    If GS sets the table, the rest of us can depend on a most filling banquet. Just make sure to finish your meal before the candles are snuffed out. There is no after-party.

  • Report this Comment On July 22, 2009, at 4:36 PM, automaticaev wrote:

    sell sell sell

  • Report this Comment On July 22, 2009, at 5:45 PM, NoMoeMoney wrote:

    This is funny, Goldman Sachs, an investment bank, is telling everyone else that you need to dance to the happy bullish tune they are playing. Meanwhile, they are most likely waiting for all the fresh fish to come swimming in so that they can feast on all unsuspecting tuna. Everybody do the dance: happy,happy,joy,joy,bull,bull,bull

    "Goldman is calling for a 44% rise in profits between this year and the next." ... Yes, with double digit unemployment and a massive inflationary bubble. The bosses must be from Califorina, cause they're smoking some serious s--- !

  • Report this Comment On July 22, 2009, at 7:12 PM, TimothyVR wrote:

    In August 1982, we were looking at the beginning of the effects of huge tax cuts, much lower inflation and interest rates and a pro-business environment.

    Today we have massive government intervention in many forms, an extreme anti-business environment in Washington, deficits that are already enormous and higher taxes. And it's just beginning.

    Big difference.

  • Report this Comment On July 23, 2009, at 9:49 AM, Gregeph wrote:

    I agree with the approach of creat326. I don't believe that anyone can consistently predict where the market will be in the short term, i.e. 6-12 months. Basing your investments on this approach will probably lead to disappointment. That doesn't mean you shouldn't have some way to gauge whether the market is overvalued. I posted a blog today about one way I gauge the market's valuation based on the market’s earnings yield.

    If you know how to analyze a business, focus on trying to find good, profitable businesses that you understand and that have a competitive advantage. Make sure that management is capable and honest and that their interests are reasonably aligned with those of shareholders. Finally, be patient and try to buy shares at an attractive price.

  • Report this Comment On July 26, 2009, at 9:10 AM, docwife wrote:

    In his determination to break health care inflation, Barak Obama and Pelosi are determined to de-stablize nearly 20% of the economy as of Jan. 1, as unemployment continues to rise. This will have a severe effect on the real estate, employment and health care suppliers industries.Doctors are already making plans to fire employees, eliminate 401K matches, reduce premium payments for health care, re-negotiate leases, and squeeze suppliers.Why? Doctors and hospitals will see drops in Medicare reimbursements as of Jan. 1, that will cripple many doctors' practices and wreak havoc with the balance sheets of all ready stressed hospitals. Many specialists will see their Medicare reimbursements cut from 20% to 40%. To give an example:cardiologists will see a 44% cut in payments for stress echoes, the fundamental test to diagnose heart disease. These payments were already cut by 25% this year. Even though research has shown that patients' heart problems are more effectively treated by cardiologists than primary care doctors, Medicare is determined to put them out of business. With their much higher malpractice premiums and larger bank loans for complex equipment, Medicare will pay heart doctors the same as family doctors to diagnose and manage patients. That placing a stent in an artery is far more risky than swabbing a throat for strep, thus resulting in high malpractice premiums for cardiolgosits and much lower premiums for family doctors, means nothing to the government bureaucrats. This is the level of understanding of health care: At his recent news conference, Obama gave this example of medical waste. A child is taken to his pediatrician because of inflammed tonsils. Instead of treating the child with antibiotics, the doctor would chose to remove the tonsils, because the reimbursement is higher. Sorry Mr. President. Pediatricians do not do surgery or remove tonsils. Only surgeons do. Why are some doctors and hospitals going along with this when they know it will mean firing employees and reducing access to care? Because in that old fashioned Chicago ganster style, they have all been threatened and intimidated. That is how a socialist economy works.

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