Taking Stock: What’s Ahead for US Markets

Market Context and Forecast

• The S&P 500 is in bear market territory, having declined up to 25% peak-to-trough.
• Goldman Sachs forecasts the S&P 500 to close 2022 around 3,600, a modest decline from current levels.
• The baseline scenario predicts continued market weakness in early 2023 until inflation data shows clearer signs of easing.
• If a recession occurs due to aggressive Fed rate hikes, the index could test lows near 3,150.
• Goldman Sachs expects the index to rise by the end of 2023, contingent on a "soft landing" scenario.

Macroeconomic Drivers

• Equity volatility is primarily driven by inflation expectations and the Federal Reserve's policy path rather than company-specific micro developments.
• The market narrative has shifted from "TINA" (There Is No Alternative) to "TARA" (There Are Reasonable Alternatives) as real yields turn positive.
• Short-term cash yields are approaching 4%, making risk-free income attractive compared to the volatility of equities.
• The Federal Reserve funds rate is projected to reach between 4.25% and 4.5% in early 2023.
• Core PCE inflation is forecast to decrease from 4.9% currently to 2.7% by the end of 2023.

Investor Positioning

• Investor exposure is below average across retail, institutional, hedge fund, and foreign categories.
• Equity mutual fund cash levels have risen to 2.5% of holdings, up from 1.25% earlier in the year.
• Net leverage among hedge funds has declined by nearly 20 percentage points, dropping from 85% to roughly 65%.
• These positioning metrics indicate a distinct "risk-off" sentiment.

Earnings Season Outlook (Q3 2022)

• Q3 earnings season begins October 14 and is expected to show 4% year-over-year earnings growth, largely driven by the energy sector.
• Excluding the energy sector, total market earnings are projected to decline by approximately 2%.
• This marks the first decline in aggregate earnings levels since the post-pandemic recovery.
• Corporate margins are anticipated to contract due to a strong U.S. dollar and rising labor and material costs.
• Pre-announcements from technology and industrial sectors indicate negative guidance for the upcoming year.

Sector Performance and Strategy

• The energy sector is generating 9–10% of S&P 500 earnings while comprising only 5% of market capitalization; its weight is expected to increase if earnings persist.
• Investors are advised to favor "quality" attributes: strong balance sheets, high returns on equity/capital, and stable growth.
• Long-duration stocks, particularly high-growth technology, face continued pressure due to multiple compression (trading at ~15x forward earnings vs. 21x at the year start).
• Within the technology sector, companies with near-term cash flow visibility are expected to outperform those reliant on distant growth forecasts.
• Corporate share repurchases remain a primary source of demand, with activity expected to resume by mid-November following earnings blackout periods.

Forward-Looking Volatility

• Equity volatility is expected to subside only after the path of inflation becomes clearer.
• Goldman Sachs estimates inflation clarity and potential volatility reduction will not occur until mid-2023.
• A sustained decline in inflation toward 3% is the critical trigger for improved investor confidence and higher equity prices.