The stock market is facing a pivotal year ahead, according to Goldman Sachs, which outlined three potential trajectories for the upcoming months. In a recent client note, the bank’s portfolio strategy team highlighted these pathways as the bull market nears its fourth year, amid growing discussions on a broadening market rally. This rally has begun to gain momentum, particularly evident in the performance of smaller companies and international stocks, which have started to outperform their larger counterparts.
To illustrate the shift, Goldman noted that the equal-weighted S&P 500 index has increased by 4% year-to-date, while the broader S&P 500 index has seen a modest gain of only 1%. The bank’s strategists, led by Ben Snider, referenced historical trends to present their forecasts for equity market expansion, which could unfold in three distinct scenarios.
The first scenario is termed “catch-down,” reminiscent of the dot-com bubble burst where the valuations of the largest stocks substantially decline. Although the strategists did not provide a specific prediction for the potential contraction, they drew comparisons to the early 2000s when tech valuations plummeted. Currently, despite concerns about high valuations in the AI sector, large-cap tech stocks maintain a forward price-to-earnings ratio of around 27. This ratio positions them in the 24th percentile relative to tech-sector premiums over the past decade. As such, the team considers a severe drop in valuations for these mega-cap tech stocks to be unlikely, suggesting that the existing disparity in valuations and returns will continue.
The second potential scenario is described as “catch-up,” where smaller stocks and other sectors experience a valuation surge. This outlook gains support from signs of accelerating economic growth during the Federal Reserve’s easing cycle. Historically, when the market conditions align, valuations for the equal-weighted S&P 500 have increased by 10% to 15% within a year, according to Goldman’s analysis dating back to 1980. However, this scenario is not viewed as the most probable outcome, with the equal-weighted S&P 500 currently priced at a price-to-earnings multiple of approximately 17, landing it in the 95th percentile of valuations since 1990. Hence, the bank argues that a significant market-wide valuation increase seems improbable under current conditions.
The final and perhaps most optimistic scenario is characterized by robust corporate earnings growth, leading to a positive broadening of the equity rally. In this scenario, many companies could exceed the performance of the largest stocks, drawing parallels to the earnings growth observed in 2021. Analysts predict that the S&P 500 will achieve an annual earnings growth rate of 15% this year, while the equal-weighted index is expected to see a 10% growth. This anticipated acceleration is viewed as aggressive compared to prior years.
Goldman Sachs believes that the extent of market broadening will be closely tied to the breadth of earnings growth, although they cautioned that the momentum might slow down as economic growth potentially decelerates in the latter half of the year. Overall, this analysis provides a nuanced perspective, laying out both the risks and opportunities that lie ahead for investors navigating an evolving market landscape.
