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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