GOLDMAN SACHS: The future of the bull market hinges on one key driver

Profit growth — the primary driver of the 8 1/2-year stock bull market — may soon be slowing. Which means something else will have to step up and take its place if the rally is to continue.

Goldman Sachs thinks the most likely solution comes from further up on the corporate income statement, in the form of revenue expansion.

In fact, companies showcasing the highest sales growth have already started proving themselves this year. A Goldman basket of high-revenue stocks has outperformed the benchmark S&P 500 by 7.3 percentage points this year, according to data compiled by the firm.

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To understand why the suggested shift is necessary to keep the bull market afloat, it first helps to understand the outsized role earnings growth has played in the third-longest period of equity expansion on record.

Since the start of the period in March 2009, higher profits have contributed 61% to the S&P 500's 270% gain, Goldman says. Of that, the firm estimates that roughly half stems from margin expansion.

Now, with higher labor costs and interest rates on the horizon, Goldman forecasts that further profit-margin growth will take a hit. It also says that valuations — currently in the 89th percentile of their 40-year history — have a low chance of continuing to expand. It's this combination of factors that makes sales growth so important going forward.

This is not to say the S&P 500 will continue to climb unabated. Due to the headwinds outlined above, Goldman sees the benchmark declining 100 points — or roughly 4% — to 2,400 by the end of the year.

Only after that will the S&P 500 continue to grind higher over the course of the subsequent two years, according to the firm. They assign a 2018 year-end price target of 2,500, largely unchanged from current levels, before the index rises climbs to 2,600 by the end of 2019.

The "near-term path of the market to 2,400 at year-end 2017 will be determined by a change in valuation (lower P/E multiple) as investors confront a higher prospective interest rate environment," David Kostin, Goldman's head of US equity strategy, wrote in a client note. "Sustained modest economic growth will support top-line revenue growth. This view supports our year-end 2019 target of 2,600."

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