Treading water before breaking the range

- "Lead indicators lost some momentum over the summer; the ISM has softened and the Euroland PMIs have started to come down from their highs. But arguably the equity market has moved to discount this ahead of the softening. Returns on equities have been on the weak side this year especially in the context of very strong earnings growth; the SXXP is up 5% year to date. We see a number of positives that should help support European equities in 2011:
1. We expect the US growth picture to improve modestly through 2011 and for concerns about a double dip to fade. Our US economists’ forecast 1.5% annualized GDP growth in 1Q2011 but by 4Q2011 they forecast growth of 3.0% annualized. The drivers of growth should also become more sustainable, US growth in 1H2010 was driven by inventories and fiscal policy whereas by end-2011 we expect more private sector demand. This more solid foundation for growth should ultimately stave off
fears of a double dip that have plagued markets for the last two years.
2. Loose monetary conditions: Our US team expects the funds rate to stay in a zero to 25 bp range through year-end 2011, as economic growth averages less than long-term potential rate and inflation continues to recede. They also expect the FOMC to resume unconventional policy easing – most likely by purchasing at least US$1 tn in Treasuries.
3. European economic growth remains robust. Despite the slight moderation in the survey data, the level of growth remains strong and there is evidence that the cycle is moving away from pure dependence on exports; in the last quarterly GDP breakdown, Germany and France saw a strong investment recovery.
4. Equities still provide attractive potential returns as the risk premium embedded in share prices remains high in our view. We expect some of this value to be realized through buybacks, increased dividends and/or M&A. Companies have strong balance sheets and plenty of firepower and increasingly those companies making strategic acquisitions are rewarded.
5. Earnings estimates have been revised up through 2010 and we also expect 2011 to be another strong year for earnings. Global growth on our economists’ forecasts remains high and companies still have catch-up growth to come through from the downturn, capacity utilization is still low in many sectors. We have updated our profit model and forecast 23% earnings growth in 2011 versus 16% for the bottom-up consensus.
- "Given this picture we upgrade – or probably fairer to say roll-on – our 12-month price target for the SXXP to 320 from 300. This would provide 23% price returns on European equities from the current level, 26%-27% including the dividend. We expect this to be driven by strong earnings growth rather than a rerating in the market, as is typical in this phase of a market recovery. It would still leave the market 20% off the highs in mid-2007."

GoldmanSachs Strategy Matters 20100924

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