Goldman CEO Lloyd Blankfein. (Photo: AP)

Goldman Sachs says the bull market in U.S. stocks should continue for another three years. In its latest market outlook, Chief U.S. Equity Strategist David Kostin is forecasting a 15% gain in the S&P 500 over that period with a target of 3,100 by the end of 2020 and a 7% gain in the index this year with a year-end target of 2,850. (The percentage changes are set against the closing price of the S&P 500 at the end of 2017).

Earnings growth will be the dominant driver of those gains, according to Goldman.

It’s projecting a 14% gain in earnings this year, led by strong sales growth and margin expansion due to the federal corporate tax cut. Without tax reform, it says, earnings would grow just 9%.

Goldman is also forecasting a 12-month forward P/E expansion to 18.2 from 17.9 in 2017 and dividend growth of 7% with a payout ratio of 35%, slightly below the 37% of 2017.

On a macro basis it expects 2.7% GDP growth in 2018 along with core PCE inflation (Personal Consumption Expenditures minus food and energy) of 1.8%, and four rate hikes by the Federal Reserve (the consensus is three).

Given this outlook, Goldman recommends three primary types of U.S. stocks:

  • companies that invest in the future, constantly redirecting cash from operations to capital spending and R&D, aka companies with a high growth investment ratio
  • companies with revenues rising 10% or more annually for several years without excessive valuations, aka Growth at Reasonable Prices (GARP)
  • companies seen as likely acquisition targets in industries with low market concentration

On a sector basis, Goldman is overweight financials and industrials; neutral on tech, health care, energy, materials and telecom; and underweight consumer discretionary and consumer staples as well as utilities and real estate.

It notes that companies with the highest tax rates should benefit the most from the corporate tax cut.

Goldman identifies 24 stocks that overlap in at least two of its investment themes (the three above plus sector plays) but only nine buys, including Alphabet (GOOGL), Deere & Co. (DE), and Comerica (CMA).

It expects S&P 500 firms will allocate 57% of cash usage for growth and 43% for return to shareholders in 2018  and expects investors will reward companies that prioritize capex and R&D.

Goldman is forecasting an 8% jump in capex, a 5% rise in dividends and a 3% increase in buybacks. It expects net inflows of $400 billion into U.S. stocks with corporate buybacks and ETFs being the dominant sources of demand.

— Check out Gary Shilling Makes the Case for Low Inflation on ThinkAdvisor.