Goldman Sachs has expressed optimism about the U.S. stock market’s trajectory, particularly in light of the Federal Reserve’s recent decision to cut interest rates for the first time since December 2024. This rate cut has contributed to a 1% weekly increase in the S&P 500 Index, which has now reached its 27th record high this year. The investment giant forecasts that if the U.S. economy can sidestep a recession, this rate-cutting cycle will act as a catalyst for continued stock market growth.
The firm’s latest analysis suggests that the trajectory of equity markets will transition from reliance on valuation expansion toward earnings growth as the primary driver. Goldman Sachs has raised its 12-month target for the S&P 500 Index to 7,200 points, indicating an estimated 8% upside potential. Their analysts anticipate that the Federal Reserve will enact two more rate cuts of 25 basis points in 2025, followed by another two cuts in 2026. This approach aligns closely with market expectations.
As investors have largely anticipated these rate cuts, Goldman Sachs warns that the potential lift to valuations from lower interest rates may be diminishing. This year, the S&P 500 has registered a total return of 14%, with earnings growth contributing 55% of this figure, and valuation expansion accounting for 37%. Looking ahead, the firm expects long-term interest rates to remain stable, which may limit further substantial declines unless the economic outlook worsens.
Goldman Sachs believes that corporate earnings will increasingly replace interest rates as the key driver of future gains in U.S. equities. Despite the ongoing highs in the stock market, investor positioning remains notably low. This underweight status positions the market for tactical upside potential, particularly in a macro-friendly environment.
David J. Kostin, the firm’s chief U.S. equity strategist, noted in their report that as the Federal Reserve’s policy direction has been factored into market prices, the dynamics driving the stock market are evolving toward a focus on corporate earnings. Currently, the forward price-to-earnings (P/E) ratio of the S&P 500 is around 22.6, slightly elevated historically, but considered to be close to fair value in the context of prevailing economic conditions.
Goldman Sachs projects a 7% growth in earnings per share (EPS) for the S&P 500 in both 2025 and 2026. Historical analysis indicates that rate-cutting cycles that successfully avoid recessions have been beneficial for equities. Reviewing data from the last 40 years, only half of the rate-cutting cycles initiated after a prolonged pause in rate hikes have led to recessions, while non-recessionary cycles have seen median returns of 8% and 15% in the six and twelve months following the cuts, respectively.
In terms of investor sentiment, Goldman Sachs’ Sentiment Indicator currently sits at -0.3, suggesting that investors are still positioned ‘underweight’ in equities. With most components of the sentiment indicator remaining within the 12-month average, there appears to be room for significant capital inflows into the stock market, particularly if the macroeconomic environment remains stable.
Given this outlook, Goldman Sachs has sharpened its investment recommendations. The firm continues to favor companies with a significant amount of floating-rate debt, which stand to benefit from declining short-term interest rates. Research indicates that a 100-basis-point drop in debt costs could lead to over a 5% increase in earnings for such firms. However, Goldman Sachs has also advised caution regarding the recent strong performance of certain interest-rate-sensitive sectors, such as homebuilding and biotechnology, suggesting that momentum in these areas could wane as further declines in long-term rates are unlikely.
In summary, Goldman Sachs has updated its forecast for the S&P 500 Index, raising its target levels for the next three, six, and twelve months to 6,800, 7,000, and 7,200 points, indicating an approximate 8% upside potential from the current levels over the next year.
