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Goldman Sachs Still Bearish on Stocks, Citing Major Downside Risks

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Despite the S&P 500 trudging steadily upward this year, Goldman Sachs is doubling down on its recent bearish call. Here’s why.

Chief equity strategist David Kostin said in a recent note to clients that the current expansion in price-to-earnings (P/E) ratio has reached historic levels. Typically this type of expansion leads to a massive crash:

The current P/E expansion cycle is now one of the largest in history. Since September 2011, S&P 500 forward P/E has grown by 75% (from 10x to 18x). This expansion has only been surpassed twice since 1976, when the multiple rose by 111% from 1984-1987 (ending with the 22% Black Monday collapse) and by 115% from 1994-1999 (ending with the Tech Bubble pop). During the nine previous P/E expansion cycles the multiple typically climbed by 50%.

Kostin went on to provide many more reasons for his bearish outlook, including weak earnings growth, pension and financials risks, wage inflation, and even a potential bombshell from the Federal Reserve:

Last week’s commentary highlighted several reasons why we believe the current 75% P/E multiple expansion cycle is unlikely to continue:

  1. already extended P/E multiple of 18x represents the 88th percentile of historical valuation;
  2. lack of earnings growth with full-year 2016 adjusted EPS expected to be flat for the third consecutive year (operating EPS up 9%);
  3. downside EPS risk as low interest rates boost pension obligations and constrain Financials’ profits;
  4. rising wage inflation that will pressure current near-record high margins;
  5. the prospect of a more hawkish Fed than the market now expects.  

The iShares S&P 500 Index ETF (NYSE:IVV) closed at $218.47 on Friday, up $0.95 (0.44%). That close was just 5 cents off IVV’s all-time high of $218.60.

Usually it pays to listen to analysts of Kostin’s stature when it comes to market calls, but he’s been very wrong in his bearish stance so far. Eventually, bears are proven correct, but the question is how much gains are you willing to give up in the meantime while waiting for the eventual pullback.

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