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Goldman: Earnings set for growth in 2014, but correction looming

Goldman Sachs' chief U.S. strategist, in an appearance Monday on CNBC, downplayed fears of a bubble in equities and the effect an expected drawdown of the Federal Reserve's economic stimulus program would have on the financial markets.

Forecasting next year's economic picture, David Kostin told CNBC that the S&P 500 could hit 1,900 by the end of 2014 and the economy will continue to improve, but investors should be prepared for a 10 percent correction during the same time frame.

"Generally speaking, earnings are rising and the economy is getting better, and that's a positive backdrop," Kostin said on "Squawk on the Street." "The second issue is the probability of a drawdown. The market is now up almost 50 percent in 18 months with no 10 percent correction. It's basically been a straight shot up."

(Read more: Goldman most upbeat on Japan, Europe stocks in 2014

Kostin told CNBC that he predicted the market had a 67 percent probability of a correction next year, based on quantitative analysis and simulations. He expected an increase in earnings per share, and that multiples will remain around 15 times earnings, saying they could jump to 16 times earnings.

Reiterating Goldman's position that the Federal Reserve would begin to taper its massive asset-purchasing program in March 2014, Kostin said low interest rates in the years after the financial crisis of 2008 allowed companies to shore up debts.

"Most companies have refinanced their debt, they've extended their maturities," Kostin said. "They've taken advantage of this very, very low, unprecedented low interest rates environment to optimize their debt profile. That's an important issue."

(Read more: Goldman predicts steep losses for gold in 2014)

Kostin also told investors to look toward companies that use capital for stock buybacks and dividends, pointing to aerospace and defense company Northrop Grumman as an example. Kostin predicts a 9 percent increase in overall capital spending by companies next year, he said.

"In general companies that buy back shares over time, that's a positive indication," Kostin said.

Traders work at the Goldman Sachs Group Inc. booth on the floor of the New York Stock Exchange (NYSE) in New York.
Peter Foley | Bloomberg | Getty Images
Traders work at the Goldman Sachs Group Inc. booth on the floor of the New York Stock Exchange (NYSE) in New York.

In July, Kostin told CNBC the markets remained fairly priced, and that the single best trade was to sell bonds and buy stocks, in particular dividend payers. He said the outlook through December was "likely to be a story of improving economic activity," and forecast that the S&P 500 could hit 1,750 by the end of the year.

The index closed trading last week at 1,805.

(Read more: Markets fairly priced, equities only place to be: Goldman)

—By CNBC's Jeff Morganteen. Follow him on Twitter at @jmorganteen and get the latest stories from "Squawk on the Street"

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