More gains ahead for US stocks?

Episode Summary

Executive Summary: Goldman Sachs strategists said the S&P 500’s 25% YTD rally has been driven by both earnings growth and valuation gains, but future upside should be more earnings-led as valuations are already rich. They raised 2025 earnings growth to 11% and see the index around 6,000 year-end and 6,300 in 12 months, while favoring mid-caps over the cap-weighted index.

Main Topics: Drivers of the S&P 500 rally (Priority: 5/5): The rally has been powered by a combination of stronger-than-expected earnings and multiple expansion, with mega-cap tech adding significant index-level lift. Updated earnings outlook (Priority: 5/5): The team upgraded 2025 EPS growth expectations materially, citing solid macro data, semiconductors, mega-cap tech, and one-time charges depressing 2024 comparisons. Valuation and fair value (Priority: 5/5): Valuations are high versus history, but Goldman’s macro model says current levels are roughly fair given growth, inflation, and Fed policy assumptions. Mid-cap opportunity vs. mega-caps (Priority: 4/5): Mid-caps are viewed as a better risk-reward opportunity because they are cheaper than the S&P 500 and may benefit more from rate cuts. AI trade and market breadth (Priority: 4/5): Investors remain most confident in AI infrastructure beneficiaries, while monetization-phase names lag; breadth improved as more stocks joined the rally. Earnings season, positioning, and flows (Priority: 4/5): Third-quarter results should be acceptable, but 2025 estimates may be revised down. Positioning is not extreme, and corporate buybacks are expected to be the largest equity demand source. Risks and event outlook (Priority: 3/5): Inflation, geopolitics, and election-period volatility are the main risks. Historically, markets weaken into elections and rally afterward.

Key Arguments: The S&P 500’s rise has been split between earnings growth and valuation expansion, unlike 2023 when valuation drove most of the return. The largest stocks, especially the Magnificent Seven, materially boosted the index; Nvidia alone accounted for more than 20% of this year’s S&P 500 return. Goldman raised 2025 S&P 500 earnings growth from 6% to 11% because of stronger macro data, semiconductor strength, mega-cap tech, and comparison effects from 2024 charges. With rates expected to stay near current levels and the 10-year Treasury only modestly higher, Goldman’s model implies S&P 500 fair value near current levels and 6,300 in 12 months. Despite rich valuations, Goldman argues they are consistent with a solid-growth, moderating-inflation, Fed-cutting backdrop rather than an outright bubble in the base case. Mid-cap stocks offer better value than the cap-weighted S&P 500 because they trade at lower multiples while still having similar growth prospects. AI investment is still in the infrastructure phase; monetization and productivity phases are later, so current upside is more valuation- and capital-spending-driven than earnings-driven. Third-quarter earnings only need about 4% EPS growth to look acceptable, but investors will focus more on 2025 estimate revisions and the outlook into 2026. The biggest near-term market risks are inflation and geopolitics; election-related weakness may be temporary and historically tends to reverse after the vote. Corporate buybacks are expected to be the biggest source of equity demand in 2025, at about $1 trillion net buying. Positioning is elevated but not extreme, suggesting neither a major tailwind nor a major headwind from investor flows.

Data Points: S&P 500 year-to-date rally: ~25% - Size of the index’s gain since the start of the year Magnificent Seven performance: +36% - Return for the largest, most visible mega-cap stocks this year Typical stock performance: ~+17% - Return for the average stock in the market this year 2025 earnings growth forecast before revision: 6% - Goldman’s prior estimate for S&P 500 EPS growth in 2025 2025 earnings growth forecast after revision: 11% - Goldman’s upgraded estimate for S&P 500 EPS growth in 2025 S&P 500 forward P/E: 22x - Cap-weighted index valuation cited by the strategists S&P 500 equal-weight forward P/E: 17x - Valuation for the equal-weighted index, excluding some mega-cap concentration effects S&P 500 valuation percentile vs. history: 95th percentile - Both cap-weighted and equal-weighted valuations were described as historically stretched 10-year U.S. Treasury yield assumption: a little over 4% - Rate assumption embedded in Goldman’s valuation model over the coming year 12-month S&P 500 target: 6,300 - Goldman’s expected index level in one year, about 8% above current levels Year-end S&P 500 target: 6,000 - Goldman’s tactical year-end forecast Mid-cap forward P/E: 15x - Valuation cited for mid-cap stocks versus 22x for the S&P 500 Mid-cap market cap range: $5 billion to $25 billion - Approximate market-cap definition used for mid-cap opportunities Third-quarter EPS hurdle: +4% y/y - Minimum earnings growth the market needs to see for a reasonable Q3 print Recent positive earnings surprise trend: ~500 bps - Typical level of upside surprise over the last five or six quarters Potential positive Q3 earnings outcome: ~9% y/y - Illustrative result if the recent surprise trend continues from a 4% hurdle 2026 S&P 500 earnings growth forecast: ~7% - Goldman’s estimate for earnings growth next year, down from 2025 but still healthy 2026 real GDP growth assumption: ~2% - Goldman economists’ annual average growth assumption for 2026 2026 sales growth assumption: ~4% - Expected sales growth, in line with nominal GDP growth Positioning indicator: 0.4 standard deviations stretched - Goldman’s sentiment/positioning measure for investors Six largest mega-cap tech stocks’ share of market cap: 30% - Concentration of the S&P market capitalization in the largest six names Nvidia’s share of S&P 500 return: more than 20% - Contribution of a single stock to this year’s index return Corporate net buying forecast for 2025: $1 trillion - Goldman’s expected net equity buying from corporates, mainly via buybacks

Pivotal Quotes: "The forward trajectory of the index is going to be driven by earnings as opposed to a valuation expansion." — David Kosten: Explaining why future S&P 500 gains should come more from profits than from multiple rerating "There is no doubt that valuations are high relative to history." — Ryan Hammond: Acknowledging that S&P 500 valuations remain stretched even after the rally "The main buyer for equities in 2025 will be corporates through corporate buybacks." — Ryan Hammond: Describing expected equity demand sources next year

Implications: For investors, Goldman’s view implies limited upside from multiple expansion and a greater need to focus on earnings quality, rate sensitivity, and valuation discipline. Mid-caps may offer better relative returns, while AI infrastructure and buybacks remain key supports.