Why US stocks may rally more than expected this year
At the start of the year, Asset & Wealth Management Investment Strategy Group (ISG) at Goldman Sachs laid out a base case for the S&P 500 to finish 2023 with a total return in low double digits at the midpoint of its 4,200 to 4,300 target range. Having reached that mark with more than half the year left to go, ISG believes the rally may have more room to run.
ISG isn’t changing its base-case target range for now, given that it was already above the consensus of around 4,000 coming into 2023, Brett Nelson, Head of Tactical Asset Allocation for ISG, writes in a mid-year update. But ISG did raise the odds of the S&P 500 reaching 4,800 — their original good-case scenario — by year-end to 25% from 20%. ISG’s forecasts may differ from those of other groups at Goldman Sachs.
The subtle upward shift is supported by a few key factors. For starters, strong first-quarter earnings have driven upward revisions in consensus expectations for full-year results. Aggregate S&P 500 earnings exceeded analysts’ estimates by about 6.5%, reflecting not only stronger-than-expected sales but also profit margins that rose for nine of the 11 S&P sectors. Notably, it was the first quarter in more than a year that the level of margins was higher than the previous quarter. As a result, about 60% of S&P 500 companies saw their full-year 2023 estimates revised higher over the past month.
“Results in the first quarter were much better than expected,” Nelson writes. “We think the hurdle for continued upside surprises is set low in Q2, as the expected sequential increase in both sales and profit margins seems conservative relative to historical averages.”
History provides a useful guide in other areas as well. Nelson highlights that past inflation peaks have been supportive for stocks. ISG also looks to the past to help make sense of currently elevated equity valuations. The beginning price-to-earnings ratio has revealed little about potential returns over any given year in the post-WWII period. Current valuations are also “unexceptional” when compared to past periods with similar interest rates, ISG notes. In addition, the report highlights that during prior periods in which the stock market recovered half of its bear market losses, as it did on May 18 of this year, the skew of subsequent returns has been favorable.
And while the top five stocks in the large-capitalization universe have accounted for more than half of the gains realized over the past six months, the historical record may be helpful here again. “Past periods of narrow breadth did not portend poor equity returns over the following year, as market participation tended to broaden going forward,” Nelson writes.
It all adds up to an argument for staying invested, even allowing for occasional market pullbacks: “Against this backdrop, we continue to recommend that clients maintain their strategic asset allocation to U.S. equities,” Nelson writes. “Pullbacks of approximately 5-10% represent normal equity volatility and not a compelling reason to underweight stocks.”
Disclaimer: The Investment Strategy Group, part of the Asset & Wealth Management business (“AWM”) of GS, focuses on asset allocation strategy formation and market analysis for GS Wealth Management. Any information that references ISG, including their model portfolios, represents the views of ISG, is not financial research and is not a product of GS Global Investment Research and may vary significantly from views expressed by individual portfolio management teams within AWM, or other groups at GS.
Forecasts are based on assumptions and are subject to significant revision and may change materially as economic and market conditions change. Past performance is not indicative of future results, which may vary.
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