NEW YORK U.S. corporate profits are poised to overtake the pre-recession record of 2007, but the rate of growth could tail off as margins compress in 2012, Goldman Sachs' chief U.S. equity strategist said on Monday.
At the Reuters 2011 Investment Outlook Summit in New York, Goldman's David Kostin said the firm continues to see the S&P 500 index .SPX ending 2011 at 1,450 points. He cut his forecast from 1,500 on May 27.
The biggest risk to that forecast is "a more significant slowdown in the U.S. economy or higher raw material prices than we are currently forecasting," Kostin said.
The benchmark stock index fell to 1,290 points on Monday, its lowest in more than two months, extending a five-week decline on worries about a slowing economy.
Fears of weakening global economic growth reflect persistent headwinds: Europe's sovereign debt troubles, the tsunami in Japan, and in the United States, falling home prices, high jobless rates and rising energy and food prices that have sapped spending power.
Investors and economists' deep concerns also center on crucial policy decisions that will help determine the nation's economic health.
Of immediate issue is the end of the Federal Reserve's $600 billion asset-purchase program at the end of June, which has been one of the economy's major supports. As policymakers gradually rein in stimulus measures, investors fear the world's economies are still too weak to thrive.
Kostin said economic conditions, while not a barn-burner, do not warrant fresh Fed stimulus. "There is economic growth, with a lack of deflation risk," he said.
Goldman Sachs assumes U.S. GDP growth for 2011 at 2.6 percent, rising to 3.2 percent in 2012, and Brent crude oil prices ending the year at $120 per barrel, rising to $140 by the end of 2012.
Against that backdrop, the investment bank currently favors large-capitalization stocks over small-cap, although the strategy has not paid off so far.
Kostin said consumer staple stocks could outperform for now and that many such firms are having success passing higher materials costs onto their users.
Energy stocks also look promising. With oil prices high, "a little bit of profitability from every business" is siphoned off into windfall profits for energy companies, Kostin said.
What's out of favor? "We're more neutral on some of the cyclical sectors," he said.
Kostin replaced Abby Joseph Cohen in 2008 as Goldman's chief forecaster of the U.S. stock market. He spent 17 years as a research analyst on Wall Street focusing on the real estate industry.
In making his market calls, Kostin draws in part from his background in applied mathematics, in which he earned a degree from Brown University.
"I'm a big believer in data," he said. "We try to keep our hands on as many micro data points as we can."
S&P 500 earnings per share are poised to climb back this year above the previous peak of $91 from 2007, Kostin said. EPS should rise to 14 percent to $96 in 2011 from $84 in 2010, and advance another 8 percent in 2012.
Among institutional investors, a big debate at the moment is around margins and whether they can continue to rise, Kostin said.
For now, Goldman Sachs says they won't. It predicts that margins will peak in 2011 and decline slightly next year.
Kostin noted the Institute for Supply Management's closely-watched manufacturing index peaked in February, at 61.4, and is now barely holding in expansion mode, above 50. It was 53.5 for May.
"History suggests that about one year after the ISM peaks, margins peak," he said.
Also on the minds of major investors is the ongoing debate over the U.S. debt ceiling and whether, and how, the U.S. budget deficit will be reduced.
"People are still hopeful of a resolution," said Kostin.
(Editing by Padraic Cassidy)