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Goldman Sachs Group Inc said that U.S. and European equities are in for a bumpy ride into the end of the year.

Brendan McDermid/Reuters

U.S. and European equities are in for a bumpy ride into the end of the year.

That's the message from Goldman Sachs Group Inc., which says that political risks, exacerbated by a weak economy in Europe and high stock prices in the United States, make those markets vulnerable to declines in the next three months. The firm projects that the S&P 500 Index and the Stoxx Europe 600 Index will each drop by about 2 per cent by December.

"We have more potential for shocks right now," Christian Mueller-Glissmann, Goldman Sachs's managing director of portfolio strategy and asset allocation, said. "We have a slight tilt to be a bit more defensive, and tilt towards Asia and emerging markets relative to more developed markets. We are a bit more bearish on Europe and the U.S into year-end."

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Goldman Sachs's prediction about Europe is more pessimistic than that of most strategists, with the average of 10 forecasts compiled by Bloomberg calling for a 1.3-per-cent rebound in the Stoxx 600 from Friday's close. The gauge has lost more than 6.5 per cent this year, and investors have pulled almost $93-billion (U.S.) from funds tracking European equities during a record 35 weeks of withdrawals, according to a Bank of America Corp. report last week citing EPFR Global data. Weighing on the shares are investor anxiety over the efficacy of European Central Bank stimulus in spurring growth and the health of the region's lenders.

In the U.S., it's the high valuations that concern Mr. Mueller-Glissmann, who says that current levels can precipitate significant drops in the event of shocks. That's the case particularly in the absence of sustainable profit growth to support prices. The S&P 500 trades at more than 18 times estimated earnings, compared with a 15.6 average for the past five years. The presidential election in November and a potential interest-rate increase by the Federal Reserve could trigger declines, he said.

Goldman Sachs equity strategist David Kostin, who was one of the most accurate forecasters last year, predicts the S&P 500 Index will finish December at 2,100, down from the close of 2,153.74 on Friday. For the rest of 2016, the firm prefers the MSCI Asia ex-Japan index and emerging markets such as China. Last month, it downgraded U.S. and European equities over a three-month horizon to the equivalent of a sell.

"Equities are a tough asset to own without a clear, positive trend in growth," Mr. Mueller-Glissmann said. "It's tough to deal with these equity draw-downs because there are very few places to hide except for cash."

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