Goldman Strategist Sees High Chance of 10% Stock Market Drop

April 9, 2014

New York (Apr 9)  Goldman Sachs Group Inc.’s David Kostin has some good news, and some bad news.

First, the bad news. There’s a good chance the U.S. stock market will see a 10 percent drop sometime during the next 12 months. Well, as far as precision goes, “good chance” is not good enough for a quant like Kostin, so he gives an exact probability: 67 percent odds of a 10 percent retreat from a peak in the next 12 months.

Though quant work can be complicated, his rationale is actually quite simple -- the market has gone way too long without a so-called correction, or a drop of at least 10 percent from a peak. The biggest declines from highs this year and last year were about 6 percent, and it’s been 22 months since the Standard & Poor’s 500 Index (SPX) saw a 10 percent drop. Mix in a little fancy math, and Kostin ends up with 67 percent odds we’ll see a correction in the next 12 months.

Now for the good news, if you can call it that: He still expects the market to end the year higher, though not by much. Kostin is sticking with his year-end S&P 500 forecast of 1,900, according to a note to clients dated yesterday. That implies a gain of less than 2.8 percent for the year and less than 3 percent from yesterday’s close. In other words, a relatively flat market given the ferocity of the gains seen in this bull run.

Next year will be better in Kostin’s view, with a gain of 11 percent to 2,100 from his 2014 forecast. The S&P 500 will add another 4.8 percent on top of that to 2,200 in 2016, he predicts.

Ho Hum

Since the beginning of the year, Wall Street strategists have held firm to forecasts for a ho-hum market this year following last year’s 30 percent rally in the S&P 500. The average projection on Jan. 3 called for a 5.8 percent gain to 1,955 in 2014, according to estimates compiled by Bloomberg. By April 1, the mean forecast had only moved up six points to 1,961.

It’s important to note in here that these oracles sort of missed the boat last year. The average estimate on Jan. 2, 2013, called for a 7.6 percent gain by the end of the year, while the S&P 500 ended up jumping 30 percent to 1,848.36. Citigroup Inc.’s Tobias Levkovich was closest at 1,615, still more than 200 points off. Kostin forecast a 2013 close of 1,575, almost 300 points off.

So if Wall Street strategists were meteorologists, last year they called for a few inches of snow and the market ended up getting a blizzard. This year, they’re calling for a dusting and so far they haven’t been too far off -- no accumulation.

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