Taking Stock: What’s Ahead for US Markets

Episode Summary

Executive Summary: Goldman Sachs strategists frame 2022 equity volatility as a macro story driven primarily by inflation and Federal Reserve policy, not company-specific fundamentals. They expect further pressure on stocks in the near term, a weaker 2023 if recession risks rise, and continued leadership from quality, energy, and companies with near-term cash flows while tech and other long-duration growth names stay challenged.

Main Topics: Inflation and Fed policy as the main market driver (Priority: 5/5): The discussion centers on inflation surprises and changing expectations for Federal Reserve tightening as the primary cause of stock market swings, with equity direction hinging on whether inflation cools or stays elevated. Market outlook and index targets (Priority: 5/5): David Koston outlines Goldman Sachs' base-case and recession-case ranges for the S&P 500, expecting modest downside in the near term and a gradual recovery later if inflation eases. Investor positioning and the shift from TINA to TARA (Priority: 4/5): Investors across retail and institutional segments are described as underexposed to equities, but rising cash yields and positive real rates create attractive alternatives to stocks, reducing marginal demand. Earnings season and margin pressure (Priority: 5/5): The upcoming third-quarter earnings season is portrayed as a key test, with expected earnings growth masked by energy strength and a likely decline in margins from currency and cost pressures. Sector rotation toward quality and energy (Priority: 4/5): In a tightening financial-conditions environment, the strategists favor higher-quality companies, while energy is highlighted as a structural outperformer because earnings share exceeds market-cap weight. Why tech remains under pressure (Priority: 4/5): Higher rates have compressed valuations most severely in long-duration growth stocks, especially technology names with cash flows far in the future, making the sector slower to rebound. Inflation as the trigger for lower volatility (Priority: 4/5): A sustained decline in inflation would improve Fed clarity, support earnings confidence, and ultimately reduce equity-market volatility, though that may not be visible until mid-2023.

Key Arguments: Inflation and Fed tightening expectations, rather than micro-level company news, have been driving market volatility. The S&P 500 could end the year around 3,600 in the base case, with a near-term trading range of roughly 3,400-3,600. In a recessionary scenario, the index could fall to about 3,150, showing downside risk remains meaningful. Investors are underweight equities overall, reflected in higher cash balances and lower hedge-fund leverage. The move from TINA to TARA matters because cash yields near 4% now compete more effectively with equity risk. Corporate buybacks should remain a major source of equity demand once blackout periods end. Third-quarter earnings are likely to show weaker underlying growth and lower margins, especially ex-energy. Energy looks attractive because its earnings contribution is far larger than its current index weight. Higher rates hurt long-duration growth stocks most, especially tech names with earnings far in the future. Volatility should ease only when inflation visibly decelerates and the Fed path becomes clearer.

Data Points: S&P 500 peak-to-trough decline: as much as 25% - Year-to-date market drawdown discussed at the start of the interview S&P 500 year-end forecast: around 3,600 - Goldman Sachs base-case target for year-end Near-term S&P 500 trading range: 3,400 to 3,600 - Expected range for roughly the next three months Recessionary S&P 500 low: around 3,150 - Potential downside in a recession scenario Equity mutual fund cash level: 2.5% of equity holdings - Current cash allocation versus earlier this year Equity mutual fund cash level earlier this year: 1.5% - Reference point for rising cash balances Hedge fund net leverage decline: from about 85% to about 65% - Evidence of reduced risk exposure among hedge funds Short-term cash return: approaching 4% - Illustrates why cash is now a viable alternative to equities Fed funds rate expectation: 4.25% to 4.5% - Expected range by early next year Third-quarter earnings growth expectation: around 4% year-over-year - Consensus estimate for the upcoming earnings season Energy sector earnings growth: more than 100% - Expected boost to headline market earnings growth Market earnings ex-energy: down around 2% - Underlying earnings excluding energy sector strength Margin direction: declining - Expected corporate margin trend during earnings season Valuation multiple compression: from 21x to around 15x forward earnings - Market-wide de-rating driven by higher rates High-growth stock drawdowns: 50% to 60% or more - Multiple compression in some long-duration tech names Energy share of market earnings: around 9% to 10% - Energy's contribution to index profits Energy share of market capitalization: around 5% - Current index weight of energy Core PCE inflation: from around 4.9% to around 2.7% by end-2023 - Goldman Sachs Economics inflation forecast Volatility horizon: at least another six months - Estimated period before inflation clarity likely improves

Pivotal Quotes: "My belief is that it is inflation and the expectations on Federal Reserve policy that have been the key drivers of the equity market." — David Koston: Explaining why the stock market has been so volatile this year "The idea of going from TINA, T-I-N-A, there is no alternative, to TARA, there are reasonable alternatives, is an important construct when we think about the supply and demand of equities." — David Koston: Discussing why higher cash yields may reduce demand for stocks "The clarity on inflation is critical." — David Koston: Summarizing what needs to happen before volatility can subside

Implications: Near-term equity returns may stay choppy and capped until inflation eases and Fed policy becomes clearer. Investors may favor quality, energy, and buyback-heavy companies, while long-duration growth names remain vulnerable.