More gains ahead for US stocks?

S&P 500 Performance & Drivers:

• The S&P 500 has rallied approximately 25% year-to-date, reaching new record highs.
• Unlike 2023, which saw roughly 75% of returns driven by valuation expansion, the current rally is driven equally by earnings growth and valuation expansion.
• The "Magnificent Seven" mega-cap tech stocks are up 36% this year, compared to a 17% gain for the typical stock, significantly lifting the aggregate index.
• NVIDIA alone accounts for more than 20% of the S&P 500's year-to-date return.
• Market breadth has improved; while AI optimism initially concentrated returns, the equal-weight index began outperforming the cap-weighted index over the summer.

Earnings & Economic Outlook:

• Goldman Sachs Research upgraded its 2025 U.S. earnings growth forecast from 6% to 11%, citing solid macroeconomic data and micro-factors in semiconductors and mega-cap tech.
• The macroeconomic backdrop assumes low unemployment, continued economic expansion, and Federal Reserve interest rate cuts.
• Third-quarter earnings expectations are set at a 4% year-over-year increase, a deceleration from the 11% growth seen in the prior quarter.
• Analysts project a range of 4% to 9% earnings growth for Q3 to constitute a positive earnings season, given recent historical surprise rates of ~5%.
• 2025 is modeled as the peak earnings growth year at 11%, with 2026 expected to moderate to roughly 7% growth, aligned with 2% real GDP growth and 4% nominal sales growth.

Valuation & Asset Allocation:

• The S&P 500 trades at 22 times forward earnings, placing it in the 95th percentile historically (ranks only below levels seen during the 2020 pandemic and the late-1990s tech bubble).
• Mega-cap tech stocks trade at 17 times earnings, also in the 95th percentile versus history.
• Goldman Sachs Research views current valuations as roughly "fair value" based on the supportive macro backdrop, implying future gains will be driven by earnings rather than multiple expansion.
• Mid-cap stocks (S&P 400, $5B–$25B market cap) are identified as a primary opportunity, trading at 15 times forward earnings with a historical track record of outperforming during Fed cutting cycles.
• Institutional equity positioning is currently 0.4 standard deviations stretched, which the firm views as neutral rather than an extreme headwind or tailwind.
• Corporate buybacks are forecasted to be the primary equity buyer in 2025, with net buying expected to reach $1 trillion.
• Other investor groups, including mutual funds, insurance companies, and pension funds, are projected to be net sellers, while households remain on the margin as small net buyers.

Investment Themes & AI Cycle:

• Goldman Sachs identifies four phases of the AI trade, with Phase 2 (infrastructure build-out) currently dominating investor conviction.
• Phase 3 (companies monetizing AI revenues) has not participated significantly in recent rallies as skepticism grows regarding returns on infrastructure investment.
• Phase 4 (productivity gains across all sectors) is viewed as a longer-term horizon not yet reflected in current earnings.
• Upcoming Q3 earnings will serve as a litmus test for whether Phase 2 infrastructure stocks can transition from valuation-driven gains to fundamentals-driven earnings growth.

Forward-Looking Targets & Risks:

• Goldman Sachs has raised its year-end 2024 S&P 500 target to approximately 6,000 and its 12-month target to approximately 6,300 (an ~8% upside from current levels).
• The model assumes the 10-year U.S. Treasury yield rises to just over 4% over the coming year.
• Historically, equity prices weaken and volatility rises in the month leading up to the election, followed by a rally once uncertainty is resolved.
• Primary Risks: Geopolitics is cited as the most immediate risk, followed by resurgent inflation that could limit Fed rate cuts.
• Secondary Risks: Disappointment in earnings, a faltering U.S. business cycle, or fiscal stimulus uncertainty in China and Europe.