Interview, Fireside Chat
Taking stock: Can the US rally continue?
- Goldman Sachs Research Chief U.S. Equity Strategist David Kostin raised the firm's S&P 500 year-end target from 5,200 to 5,600, a revision reflecting modestly higher fair value estimates and more resilient earnings expectations than historical norms.
- The U.S. equity rally year-to-date is highly concentrated, with the top five stocks (NVIDIA, Amazon, Microsoft, Alphabet/Google, and Meta) responsible for 60% of the index's 15% gain, while the typical stock in the index rose only 5%.
- Fundamentals supporting the top five AI-driven companies are distinct from the broader market; these companies posted 84% earnings growth in Q1 versus a 5% increase for the rest of the market, and analysts have raised their earnings estimates by 38% for this group compared to a 5% cut for the rest.
- Investor sentiment has pivoted in recent weeks from AI euphoria to skepticism regarding the timing and magnitude of revenue gains from corporate AI investments, with Kostin noting that earnings reports in the second half of 2024 and early 2025 will be critical for validating these expenditures.
- The S&P 500 currently trades at 21 times forward earnings, positioning it near the 91st percentile historically; Kostin's models project a slight multiple compression to approximately 20.5 times by year-end, driven by valuation models and current real interest rate levels.
- Market valuation is linked to the long end of the yield curve, with 10-year U.S. Treasury yields at roughly 4.25% and real yields near 2%, whereas the Fed's potential rate cuts are expected to disproportionately benefit small-cap stocks due to their higher exposure (approx. 30%) to floating-rate debt.
- Forward-looking earnings expectations for 2025 indicate modest growth of around 6%, which aligns with Goldman Sachs' 12-month forecast of the S&P 500 closing at 5,700, suggesting the market is fairly valued relative to this earnings trajectory.
- Historical election patterns suggest equity volatility and potential downside risk in the months leading up to the November election, followed by a significant market rally once uncertainty is resolved, though the 2024 election carries heightened risk of a delayed resolution due to mandatory recount rules in closely contested states.
- Policy uncertainty regarding tariffs has created a divergence in stock performance; domestically focused companies have outperformed internationally exposed firms by approximately 5 percentage points this year as investors price in risks of retaliatory tariffs.
- The primary downside risk to the current market forecast is a "dot-com style" compression of multiples if the financial benefits of AI investments fail to materialize at the pace currently priced in, particularly given the significant valuation premiums held by the top five tech names.
- Share demand sources remain robust despite concentration risks, with corporate share repurchases expected to reach $934 billion this year and a secular shift from active to passive funds creating net buying pressure on large-cap tech stocks, as active managers remain underweight these names to comply with diversification regulations.
- Hedge funds remain significantly overweight in the largest technology companies, contrasting with the underweight positioning of actively managed mutual funds, which are forced to diversify away from the index's top concentrations due to SEC rules limiting single-stock exposure in diversified funds.