Goldman Sachs’s recent note maintains that S&P 500 will be 1250 at year’s end, when currently it is at 1418 signifying huge downside

David Kostin, who recently replaced perma-bull Abby Joseph Cohen as Goldman Sachs US Chief Equity Strategist, has warned investors that S&P is likely to fall from the highs it had been scaling. He is maintaining the year end target that S&P 500 will end the year at 1250 and not revising it up, despite current bullishness prevailing in the markets. This means he expects markets to fall over 11% from current levels of 1418. Whether Goldman Sachs is serious (as they are notorious for short-changing their own clients) is anybody’s guess. However, the analysis is certainly food for thought, given that the markets world over is peppered with bullish analyses and investors in recent weeks.
 

One of the key points in Goldman’s analysis is the issue of “fiscal cliff” or the massive trillion dollar deficit that America is currently facing. Unless America’s decision makers address this issue rather than act in the last minute, it is unlikely that the market will move up significantly.
 

It said in its note, “A look at the 2011 trading pattern of the S&P 500 explains the reason for our belief that the market has an asymmetric risk profile and offers more downside than upside. Last year the deadline for Congress to raise the federal debt ceiling was known months in advance. Nevertheless, Congress was unable to reach an agreement that satisfied all factions. Investors were stunned and the S&P 500 plunged 11% in 10 trading days (and more than 17% from the level one month prior to the deadline).”
 

With the American elections in full flow, and lots of countervailing points of view between the incumbent Barack Obama and Mitt Romney (who promised to do away with “Obamacare” a major component of the debt ceiling), there is the eternal question of whether the debt ceiling will be raised, whoever the president elect maybe. The debt ceiling denotes how much the American Government can borrow from the world to plug the deficit. At the moment, it is nearing the limit, after which, it must pass another law in order to raise it or be forced to undertake austerity measures which will affect not only America but the rest of the world as well. The note said, “If no agreement on ‘fiscal cliff’ issues is reached before the election, it will require a lame duck Congress to address the topic. Although the official debt ceiling is likely to be reached in December, Treasury legerdemain will allow the government to be financed under the limit until February 2013, by which point the debt ceiling must be raised.”
 

Despite obvious facts staring right at investors’ faces, the market has moved up which, according to Goldman Sachs, is unusual and not quite rational. “In our opinion, equity investors seem unduly complacent on this issue (i.e. fiscal cliff). Portfolio managers have been swayed by hope over experience,” the note remarked on the investors’ expectations.
 

In case US policy makers fail to address the “fiscal cliff” at any point of time, the investment bank expects the American economy to contract 0.4% in 2013, which is a massive amount of money. The note said, “Goldman Sachs US Economics research estimates that the impact of the fiscal cliff would weigh on real 2013 GDP growth by nearly 4 percentage points if scheduled year-end policy changes were to take effect permanently. Applying this to our US economists’ forecast, GDP would contract by roughly 0.4% in 2013.” According to Goldman Sachs, this would mean S&P would touch 1120.

However, if the debt hole is addressed, it expects the US economy to expand by roughly 2.7% and see S&P go up to 1540.
 

So far the S&P 500, as well as the global markets has been helped by a lot of factors despite headwinds. For instance, Angela Merkel seemingly supportive comments of the European Central Bank (ECB) helped the market a lot given that she has been the most vocal critic of the EU attitude towards bailouts and such. Other risks, according to the note include, “US election; China growth; European political, sovereign debt, and bank funding crises; and Iran/Israel tensions.”
 

The investment bank expects policy makers to address the fiscal cliff but warned that, “investors must confront the risk they (policy makers) may not act until the final hour“. In other words, expect a lot of uncertainty in the United States political battlefield which could affect the outcome of S&P 500 and the markets.