Goldman Sachs has lowered its outlook for the S&P 500 by the end of the year by 50 points.
1. Raising our 2010 earnings estimate to $81 from $78. For the second time in two months we are boosting our 2010 operating EPS estimates for the S&P 500. Profit margins for the S&P 500 (excluding Financials and Utilities) reached 8.0% for the four quarters ended in 2Q 2010, fully 96% of its previous cycle high and 290 bp above the low of 5.9% reached in the recent downturn. The primary drivers of our $3 per share increase in 2010 EPS estimates include Industrials ($1) and Information Technology ($1).
2. Cutting our 2011 earnings estimate to $89 from $93. Our US Economics team recently lowered its annual average GDP growth forecast for 2011 to 1.9% from its previous estimate of 2.4%. US GDP growth is a key input into our sales and margin forecasts. Cutting our 2011 EPS estimate to $89 represents a reversal for us because, at the end of May, we raised our 2011 EPS estimate to $93 from $90. It was a badly timed decision in retrospect. The economic landscape has eroded significantly during the last two months. A combination of reduced earnings from Energy (-$3), Health Care (-$1) and Financials (-$1) partially offset by increased profits from Information Technology (+$1) explain the EPS cut.
3. Reducing our year-end 2010 target for the S&P 500 to 1200, 7% above current levels.
We place a greater emphasis on the results of our Dividend Discount Model (DDM) compared with the other valuation approaches. Our DDM model is highly sensitive to the cost of equity and the long-term rate of inflation. A 10 bp change in either input adjusts the forecast 2010 year-end fair value of the S&P 500 by approximately 50 points, or almost 4%.
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