It's not just former Fed economists who are getting worried. So is Goldman.

As we wrote last weekend, "With "Stock Valuations At Extremes" Goldman's Clients Are Asking Just One Question", namely how much longer can the rally continue.This followed another Goldman warning from two weeks ago, where as we noted before, "Goldman Warns Of A Sharp Plunge In Stocks In "Next Few Months."

Who knows: maybe Goldman will be right and the market will plunge - it certainly isn't trading at all time highs and 25x GAAP multiples on fundamentals. But for now those who heeded Goldman's warning and traded ahead of a 10% "pullback" have gotten crushed.

So has Goldman's chief equity strategist David Kostin finally thrown in the towel?

Not yet. In fact, Kostin appears to be doubling down, and as he observes (correctly) overnight, the one sole reason behind the market rally in recent years - clearly not earnings growth as we wrote earlier - namely, multiple expansion, is now substantially overdone. And not just that: as Kostin points out, there have been only two time in history when the P/E multiple has expanded as much (75%) or more as it has in the current cycle: 1984-1987 and 1994-1994. Both ended with historic crashes. To wit:

The current P/E expansion cycle is now one of the largest in history. Since September 2011, S&P 500 forward P/E has grown by 75% (from 10x to 18x). This expansion has only been surpassed twice since 1976, when the multiple rose by 111% from 1984-1987 (ending with the 22% Black Monday collapse) and by 115% from 1994-1999 (ending with the Tech Bubble pop). During the nine previous P/E expansion cycles the multiple typically climbed by 50%.

Thanks, David, we get it. It's going to end very badly. Just maybe tell your friend Bill Dudley to stop pushing it ever higher and assuring the resulting crash will be that much worse, maybe?

And speaking of that, will the market continue to levitate on even more multiple expansion or is a sharp drop just around the corner? According to Goldman, the answer is the latter:

Last week’s commentary highlighted several reasons why we believe the current 75% P/E multiple expansion cycle is unlikely to continue:

1. already extended P/E multiple of 18x represents the 88th percentile of historical valuation;
2. lack of earnings growth with full-year 2016 adjusted EPS expected to be flat for the third consecutive year (operating EPS up 9%);
3. downside EPS risk as low interest rates boost pension obligations and constrain Financials’ profits;
4. rising wage inflation that will pressure current near-record high margins;
5. the prospect of a more hawkish Fed than the market now expects.  

We maintain our S&P 500 year-end 2016 price target of 2100, although 5%-10% near-term downside risk remains high.

Instead of ending it on an apocalyptic note, here is Goldman with a useful detour on the most topical issue right now: the Fed model.

Finally, some thoughts on what has been the better trade YTD: stocks or bonds...

Bonds have delivered a higher risk-adjusted return than stocks YTD. Bonds have returned 7.6% YTD as rates fell from 2.3% at the start of the year to 1.6% today with realized volatility of 5. The S&P 500 has posted a similar absolute return YTD (+7.2%) but has been on a rollercoaster path (volatility of 12). The YTD Sharpe Ratio for equities is just 0.6 versus 1.5 for bonds.

... and what will be going forward:

Consensus expects S&P 500 will generate a higher risk-adjusted return than bonds. A weighted average of consensus price targets for all S&P 500 constituents implies an index level of 2330 in 12 months (+9.8% return with dividends). Implied volatility for the S&P 500 over the next 12 months equals 15.9 leading to a prospective Sharpe Ratio of 0.62. Futures imply a 12 month return of 0.7% for 10-year Treasuries (ending yield of 1.7%). Implied volatility of 5.1 results in a prospective Sharpe Ratio of 0.15 for bonds.

In contrast, we forecast a similar 12-month risk-adjusted return for equities as the futures market implies for Treasuries. Our 12-month S&P 500 target equals 2150, reflecting a potential total return of 1.5% including dividends. The resulting equity Sharpe Ratio would be 0.10, similar to the 0.15 ratio for bonds. Since 1990, the risk-adjusted returns for equities have typically been roughly equal to bonds (0.98 vs. 1.01).

What Goldman does not touch on, however, is the circular nature of fund flows, where if bond yields do surge - as some are warning may happen soon on fears of an inflationary spike - it will lead to not only a rates VaR shock and massive MTM losses (as big as $2.5 trillion), but also to downstream liquidation in equities, which in turn will lead to a flight to safety... right back into bonds. And so on until something finally does break.