A Confused Goldman No Longer Expects S&P To Drop To 2,400 But Sees No Market Upside Either

Mea culpa in hand, Goldman then pushes back on calls for even more upside, admitting that "from a fundamental perspective, the upward trajectory of the US equity market during the past two months is unlikely to persist for several reasons..." 

(1) Our S&P 500 earnings growth expectations for 2021 are achievable, but optimistic, and investors will need to see more evidence that firms across all industries can deliver on those projections;

(2) Based on our macro model, the current index level implies normalization occurs smoothly and meeting that expectation will only support and validate the existing market level rather than push it higher; and

(3) The current rally has generally been powered by a small group of secular growth stocks. A further advance in the index will require broader participation by more economically-sensitive companies but many of these firms will have lower earnings next year than in 2019."

Another caution from Kostin is that the blistering rebound of the S&P 500 index overstates the performance of the typical stock. Consider the following:

  • The equity capitalization-weighted S&P 500 index has rebounded by 35% from its low and now trades just 11% below its all-time high. The index return since the start of the year is -6%.
  • And yet, at the same time, the average stock has returned -13% YTDThe equal-weighted S&P 500 index trades 15% below the record high and has lagged the cap-weighted index by 650 bp this year, a testament to the narrow breadth of the index recovery.

Indeed, the stellar return of the five largest stocks in the S&P 500 -- MSFT, AMZN, AAPL, GOOGL, and FB -- is the primary explanation for the large difference between the cap-weighted index and the average stock

Reminding clients that the current aggregate index weight of the five stocks with the largest market caps - the FAAMGs - is the highest in history.

Kostin writes that broader participation in the rally will be needed in order for the aggregate S&P 500 index to climb meaningfully higher. This won't happen according to Goldman equity research analysts, who currently forecast just 1% upside for the cap-weighted group of the five stocks. The modest upside for the largest stocks means the remaining 495 constituents will need to rally to lift the aggregate index.

There are two other key market-related risks to further upside according to Goldman:

  • The first, as noted above are the elevated positions of hedge funds and retail investors, which suggest that purchases by the two investor classes have now likely peaked.
  • Second, Kostin warns that the sharp ongoing reduction in buybacks poses a risk to the balance of US equity supply and demand. US companies have represented the largest source of demand for US equities each year this cycle. However, plunging cash flows are leading to a sharp reduction in repurchase activity this year. So far, nearly 100 S&P 500 companies have suspended their buyback programs this year, accounting for more than 40% of 2019 buyback executions. Goldman forecasts S&P 500 gross buybacks will decline by 50% to $371 billion in 2020 from $749 billion in 2019. Consequences of the sharp reduction in corporate repurchases include lower EPS growth, higher share price volatility, and lower equity valuations.
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