Here's Goldman's market outlook for the next two years and how to play it

Published Tue, Jul 6 202112:13 PM EDTUpdated Tue, Jul 6 20211:19 PM EDT

A top Goldman Sachs equity strategist thinks the S & P 500 won't be too far from where it is now by the end of 2021, but that stocks could be set for a decent 2022 as growth strategies overtake value. Chief U.S. equity strategist David Kostin told clients in a weekly update that he sees the broad market index finishing 2021 at 4,300, about 50 points below where it closed on Friday. He blamed near-term headwinds like higher borrowing costs and the prospect of Biden tax reform for the muted forecast for the rest of the year. "Our economists' expectations of higher interest rates and higher corporate tax rates by year-end are the primary reasons we forecast that the S & P 500 will trade sideways during the next six months," Kostin wrote. An upcoming rally After a sideways second half of 2021, equities should rally about 7% in 2022 as companies that have invested in growth in recent years lap those tied to the U.S. economy, the bank explained. Kostin expects the 500-stock index to rally to 4,600 by December 2022. Companies with businesses linked to accelerations and decelerations in U.S. gross domestic product outperformed in the first half of 2021 as Covid-19 vaccine distribution allowed consumers to resume normal activities. Energy stocks in the S & P 500, tracking a rebound in West Texas intermediate crude prices from $45 a barrel to north of $70 a barrel, posted their best first half ever with a whopping 42% rally. Gravel supplier Martin Marietta climbed 24% during the six months that ended June 30, while JPMorgan Chase popped 22% over the same period. Reopening plays Carnival and Gap rose 21% and 66%, respectively. But as pent-up demand for clothing, airfare and energy diffuses throughout the U.S. economy, growth-focused firms that had been out of favor in early 2021 should be more apt to catch a bid from traders, Goldman's Kostin wrote. Second-half tactics Kostin laid out three strategies investors hoping to make the most out of a choppy second half. First, the strategist reiterated a tactic he touted in March: Finding stocks with short "duration." Goldman is looking at duration as a measure of how quickly a company can repay shareholders through earnings. These companies have strong cash flows sooner, and as a result, their valuations are less beholden to the future level of interest rates. Companies with long-term growth profiles, and especially those that don't currently generate positive net income, tend to have long duration metrics. More established companies, perhaps with more modest growth prospects, have shorter durations. Investors tend to like short duration stocks when interest rates are on the rise since higher rates reduce the value of future earnings. Goldman, for example, forecasts the rate on the benchmark 10-year Treasury note to climb to 1.9% by year-end and 2.1% by the end of 2022. That yield was last seen around 1.36%. Second, Kostin likes the look of growth stocks toward the end of 2021 and into 2022. He argues that U.S. gross domestic domestic growth has peaked, or will soon peak, meaning that economic activity will be decelerating by the fourth quarter of 2020. "[We] expect decelerating economic growth will support the outperformance of Growth versus Value in late 2H and into 2022, but the trade will remain volatile in the near-term," he wrote. "Economic growth deceleration generally supports owning Growth, but both rising interest rates and the passage of a fiscal package, including infrastructure and tax reform, would benefit Value and therefore suggests a choppy outlook for the trade in coming months." Third, Goldman recommends investors look to own companies that have strong pricing power to offset any unruly increases in inflation. Stock of companies with strong pricing power outperformed in 2018 and 2019 as wage growth accelerated and profit margins declined, Kostin wrote. Though Goldman's economists believe any uptick in prices to be transitory, the bank noted that an environment of shrinking margins and a tighter labor market could benefit that group. — CNBC's Michael Bloom contributed reporting.

David Kostin, Goldman Sachs chief U.S. equity strategist, speaks during an interview with CNBC on the floor of the New York Stock Exchange, July 11, 2018.

Brendan McDermid | Reuters

A top Goldman Sachs equity strategist thinks the S&P 500 won't be too far from where it is now by the end of 2021, but that stocks could be set for a decent 2022 as growth strategies overtake value.