Goldman Plays Nostradamus, Sees S&P Surging By End of 2015

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With all the uncertainty out there about the Federal Reserve, fiscal policy, Europe and North Korea, one would think it's hard enough to give an equity forecast for the end of this year. But the gang at Goldman is taking a stab at predicting market returns until 2016.

The global equity team at the elite Wall Street firm sees 9 percent annual total returns for the S&P 500 ahead, pushing the index up 20 percent to 1900 by the end of 2015. They see even bigger returns for Japan, Europe and the rest of Asia.

Gains will be "driven by strong earnings growth supplemented by a good dividend yield and some expansion in multiples," states the strategy paper. The forecasts rely "upon our economists' scenario for future economic activity and the tools for modeling earnings and discount rates that have so far been important inputs for setting our 12-month index targets." (Read More: You Must Understand This About Yield)

The firm sees 21 percent annual returns in the Asia ex-Japan region over the next three years, followed by 19 percent a year in Europe and 15 percent annual gains in Japan.

Before chastising the firm for being brash enough to believe it can predict this far into the future, realize that Goldman does acknowledge there are key risks to these forecasts, most notably a disappointing economic recovery, a peak in profit margins and a lack of multiple expansion. (Read More: The Euro Zone Crisis Is Back—On Multiple Fronts)

"We judge markets to be roughly fairly priced for the current economic environment and therefore returns are unlikely to materialize on a sustained basis unless the economic recovery continues," states the report to clients late yesterday.

The firm sees the global economy expanding at a 3.3 percent pace this year and then accelerating to 4 percent from 2014 through 2016.

For the U.S., if margins were to peak and decline to their 20-year average, that would bring the firm's long-term S&P 500 forecast down to 1700 or a 5.5 percent annualized total return for three years.

If the price-earnings ratio for U.S. stocks fails to expand, it would be even more damaging to stocks, lowering the long-term S&P 500 target to 1600 or just 3.4 percent total annual return through 2015, Goldman says.

Addressing the big worry at the moment about the Fed's tapering off of quantitative easing, the firm does not see higher interest rates as a risk to equity long as they're rising for the right reasons.

Goldman sees U.S. rates to hit 2.5 percent by the end of 2013 and then a gradual increase to 3.75 percent by the end of 2016.

"Historically, increases in yields from low levels driven by better growth have been associated with a rising rather than a falling equity market," write the strategists. "If, on the other hand, rates were to rise on the back of higher inflation expectations or an unexpected early tightening of monetary policy against our views this would likely be a headwind to equities."

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