Dow Jones Industrial Average, S&P 500: Goldman Sachs Group Inc Warns Of A Sharp Plunge In Stocks In “Next Few Months”

market correction bearTyler Durden:  That Goldman’s David Kostin has been warning about the possibility of a sudden, sharp drawdown in the market, is not new: we first reported on that in early May when we presented “Six Reasons Why Goldman Is Suddenly Warning About A “Large Drop” In The Marketin which we cited the head Goldman equity strategist who said that “unbalanced distribution of upside/downside risks suggests “sell in May” or buy protection.”

He adds that “we continue to expect S&P 500 will end 2016 at 2100, roughly 3% above the current level even as “a shift in investor perception of various risks could easily trigger a drawdown.”

Specifically, he warned that “a drawdown during the next few months could find the S&P 500 index falling by 5%-10% to a level between 1850 and 1950. 16 drawdowns greater than 5% have occurred since 2009, including the 13% correction that lasted 3 months and ended in February (Exhibit 1). S&P 500 trades at 2047 and has a forward P/E of 16.7x based on bottom-up adjusted EPS of $123. A 5% pullback would lower the P/E to 15.8x, implying an index level of 1950. A 10% correction would reduce the P/E to 15.0x and the index level to 1850.”

Two months, and one brief Brexit swoon later, Goldman is back with another similar warning, now expecting a 5-10% drop in the “next few month”, which Goldman expects will be met with another round of BTFDing, and pushing stocks once again higher, as they close the year at 2,100. To wit:

The S&P 500 enters 2H 2016 just 3% above where it began the year. Tactically, we continue to expect the market will experience a pullback of 5%-10% during the next few months before ending the year at 2100. Strategically, we expect a continuation of the range-bound market that has challenged investors for nearly two years. Although investors appear complacent in the wake of Brexit, a maturing economic cycle with elevated valuations, decelerating buybacks, and growing political uncertainty provide the basis for potential market weakness in the second half. At the same time, above-trend US economic growth, a return to positive but slow earnings growth, a cautious Fed, and the lack of investment alternatives around the globe will support equity prices without providing a catalyst for further upside. Our 3-, 6-, and 12-month S&P 500 price targets are 1950, 2100, and 2150.

Just like in May, Kostin blames the upcoming selloff on a “drawdown” in risk, one which he expects will trough when PE multiples hit 15x.

Most recent drawdowns have troughed at a forward P/E of roughly 15x. Given consensus bottom-up next-12-month EPS of $123, this same multiple would value the S&P 500 at roughly 1850, or 13% below its recent high of 2115 reached in early June. In 16 S&P  500 pullbacks of 5% or more since 2009, the S&P 500 has declined by a median of 7%, which would bring the S&P 500 to roughly 1950.

A small problem emerges if looking at earnings on a GAAP basis, where the S&P500 is currently trading in the mid-20x PE multiple, so if indeed one targets a 15x trough, then there is a far longer way down than what Goldman estimates.

Finally, for what Goldman thinks may be the catalyst for this upcoming slump, Goldman points out that “the fallout from Brexit is just one of several headwinds to US equity returns in the next few months. Other risks include the upcoming US presidential election, unstable growth and policy in China, and a deceleration in corporate buybacks, which represent the largest source of demand for US equities.” 

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