The Latest Outlook for U.S. Equities

Episode Summary

Executive Summary: David Kostin says the S&P 500 has fully recovered to its February high, but the move reflects lower earnings and higher valuations driven by Fed and fiscal support. He expects 3,600 year-end and 3,800 by mid-2021, with technology, industrials, and utilities favored, while healthcare, real estate, and energy face pressure. Market concentration in mega-cap tech remains a key risk.

Main Topics: Market rebound and revised S&P 500 outlook (Priority: 5/5): Kostin explains that the index is back to its pre-pandemic high after an historic drawdown, but the recovery is driven by policy support and valuation expansion rather than a full earnings recovery. Goldman’s forecast rises from 3,400 to 3,600 for year-end 2020 and 3,800 for mid-2021. Vaccine, fiscal policy, and election uncertainty (Priority: 5/5): Investors are focused on whether a vaccine arrives by late 2020, how quickly immunization rolls out in 2021, and what the election means for taxes and fiscal policy. Goldman’s forecasts assume a vaccine develops on schedule and tax policy remains unchanged for now. Sector positioning under low-rate and recovery conditions (Priority: 5/5): Technology benefits from very low interest rates because future cash flows are worth more today, while industrials benefit from economic reopening and recovery. Utilities also gain appeal because low yields make their dividends relatively attractive. Sectors under pressure: healthcare, real estate, energy (Priority: 4/5): Healthcare faces election-related regulation and drug-pricing concerns; real estate is hurt by store closures, bankruptcies, and office-space reassessment; energy is weighed down by weak oil prices and lower cash flows. Market concentration and big-tech risk (Priority: 5/5): The top five U.S. stocks now represent nearly a quarter of S&P 500 market cap, creating portfolio constraints and narrow market breadth. Kostin flags antitrust and regulatory scrutiny as potential risks to concentrated leaders. Large-cap outperformance and balance-sheet strength (Priority: 4/5): Large caps are supported by stronger fundamentals, especially better balance sheets and more international revenue. Smaller, weaker-balance-sheet firms have lagged, suggesting investors remain cautious despite the index’s recovery.

Key Arguments: The market’s return to its February high masks a major shift: earnings expectations have fallen while valuation multiples have risen, helped by lower interest rates. Fed policy and congressional stimulus were the main forces behind the rebound from the March lows. Investor base cases assume a vaccine by October, FDA approval by year-end, and broad vaccination in the first half of 2021. Goldman’s 2021 GDP outlook is notably above consensus, implying stronger earnings growth if the recovery proceeds as expected. The election creates uncertainty around corporate taxes, but Goldman is currently assuming no tax-policy change in its forecasts. Technology is favored because low rates increase the present value of long-duration cash flows. Industrials should benefit from an economic recovery and reopening cycle. Utilities are attracting more attention because low rates make their dividend yields comparatively compelling. Healthcare is under pressure from election-year regulation fears and possible drug-pricing action. Real estate remains challenged by changes in retail and office demand, while energy suffers from low oil prices. The market is unusually concentrated, and this concentration raises both portfolio-management constraints and antitrust risk. Large-cap dominance is fundamentally justified by stronger balance sheets and less severe earnings declines than smaller companies. If the economy were healing broadly, smaller caps and weaker balance-sheet stocks would be recovering more strongly; their weakness signals persistent caution.

Data Points: S&P 500 peak before selloff: Feb. 19, 2020 - The index hit an all-time high just before the pandemic-driven selloff. Bear market speed: 22 days - Kostin describes the pandemic decline as the fastest and steepest bear market in history. Market decline from peak: more than 30% - The S&P 500 fell over 30% during the downturn. Market rebound from trough: 50% - The index rallied about 50% from the bottom. Two-year-ahead earnings expectations: down around 10% - Forward profit expectations fell even as the market recovered. PE multiple expansion: up around 10% - Higher valuation multiples offset the decline in earnings expectations. Current forward P/E: around 19x two-year forward estimates - Kostin says this is high relative to history. Interest rates change: down 1 percentage point - Lower rates helped justify higher equity valuations. Goldman year-end 2020 S&P 500 forecast: 3,600 - Raised from the earlier 3,400 forecast. Goldman mid-2021 S&P 500 forecast: 3,800 - Implied roughly 12% price appreciation plus dividends. Expected total return over 12 months: around 14% - Approximately 12% price gain plus 2 percentage points of dividends. Goldman U.S. GDP forecast for 2021: 6.2% - Above the consensus estimate of 3.9%, dependent in part on vaccine rollout. Consensus U.S. GDP forecast for 2021: 3.9% - Benchmark used to show Goldman’s more optimistic view. Federal funds rate: 0 to 25 basis points - Kostin says policy is at the lower bound. Utilities dividend yield: more than 3% - Low rates make these yields relatively attractive. Utilities yield gap: widest in 25 years - A key reason for growing investor interest in the sector. Virtual utilities conference attendance: up 30% year over year - Evidence of rising investor focus on utilities. Top five U.S. stocks share of S&P 500 market cap: 23%-24% - Shows record concentration in the index. Top five stocks share at 2000 tech bubble peak: around 18% - Used as a historical comparison for concentration risk. Top five stocks YTD performance: up 41% - These stocks have driven most of the index gains. Other 495 stocks YTD performance: down 2% - Demonstrates narrow market breadth. Second-quarter earnings for S&P 500: down 34% year over year - Reflects the pandemic-induced economic freeze. Second-quarter earnings for small caps: down 97% - Shows much greater stress among smaller companies. Strong vs weak balance sheet performance gap: about 30 percentage points - Strong-balance-sheet stocks outperformed weaker ones by a wide margin.

Pivotal Quotes: "In 22 days, the market fell by more than 30%. But remarkably, it's rallied back by 50% since the trough." — David Kostin: Summarizing the extreme pandemic market swing and rebound. "It's basically been a situation where there's less profits, but a higher valuation on those profits." — David Kostin: Explaining why the index is back at its prior high despite weaker earnings. "If the investor community really believed that the economy was in a healing way and getting better... smaller cap stocks should do better. But they're not." — David Kostin: Using small-cap underperformance to argue investors remain cautious.

Implications: Investors should expect a market led by policy support, low rates, and selective sector winners rather than a broad-based cyclical boom. Mega-cap tech remains powerful but concentrated, while valuation and regulatory risks stay elevated.