What Next for S&P 500 - 6300 or 4800?

Archive edition · Market data and company circumstances reflect 21 June 2024, when this newsletter was sent.

Goldman Sachs Raises S&P 500 Target

Goldman Sachs increased its year-end target for the S&P 500 to 5,600, citing better-than-expected earnings from mega-cap tech stocks and a slightly higher fair value P/E (price-to-earning) ratio. The revision comes despite analysts typically lowering earnings estimates throughout the year.

S&P 500 index path to 5600 at year-end 2024

Strong growth by Apple, Microsoft, Nvidia, Google, and Meta has offset these downward revisions for other sectors. Goldman Sachs expects the S&P 500 to trade at a P/E ratio of 20.4x by year-end, down slightly from the current level of 21.1x.

Tech Stocks Driving the Market

The S&P 500's impressive performance in 2024 can be largely attributed to the phenomenal rise of a select few. Unlike a typical year where diverse sectors contribute to growth, this year is dominated by a handful of tech giants. Apple, Microsoft, Nvidia, Google (Alphabet), and Meta Platforms (Facebook) have become the market's driving force.

These mega-cap tech stocks have delivered stellar earnings, exceeding analyst expectations by a significant margin. Their combined growth has effectively masked weaker performances in other sectors. This lackluster performance from non-tech companies goes unnoticed because the tech giants' outsized gains hold so much weight in the market-cap weighted S&P 500.

Five stocks account for 60% of S&P 500 return YTD

Here's where the concept of P/E ratio comes into play. The P/E ratio, or price-to-earnings ratio, is a metric used to gauge a stock's valuation. A fair P/E for the equal-weight S&P 500, where all companies have the same influence, is estimated to be around 15x. However, the S&P 500 assigns weightings based on market capitalization, meaning companies with higher stock prices have a greater impact on the index. This skews the P/E ratio upwards due to the tech giants' high valuations.

In simpler terms, the exceptional performance of these tech stocks is inflating the S&P 500's valuation. While it appears the market is doing well, a closer look reveals a more nuanced picture. The success of a few tech companies is masking underlying weaknesses in other sectors. This raises questions about the market's long-term sustainability if diversification is lacking.

It will be interesting to see how this dynamic plays out. Will other sectors catch up and contribute to a broader market rally? Or will the tech titans continue to dominate, pushing the S&P 500's valuation even higher? Only time will tell, but for now, the tech revolution is steering the ship in the stock market.

Earnings Revisions: Milder Than Expected

Earnings revisions for the S&P 500 have been milder than expected. This defies the historical norm where analysts typically adjust estimates downwards throughout the year.

The culprit behind this shift? The phenomenal performance of a select group of mega-cap tech stocks.

Let’s take a deeper dive:

• Historical Pattern: Traditionally, analysts reduce earnings estimates for the S&P 500 by an average of 7% from June of the previous year onwards. This downward revision reflects a conservative approach as companies navigate various challenges.
• 2024's Deviation: This year, however, the revisions have been significantly milder. Goldman Sachs reports that estimates haven't been cut at all year-to-date. This is a stark contrast to the usual 7% reduction by June.
• The Tech Powerhouse: The key driver behind this milder revision is the exceptional performance of tech giants like Apple, Microsoft, Nvidia, Google, and Meta. These companies have reported blowout earnings, exceeding analyst expectations by a substantial margin. Their combined earnings growth has effectively offset downward revisions that might have been applied to other sectors.

Alternative Scenarios: Beyond the Base Case

Goldman Sachs also explored four potential future scenarios for the market, offering investors a broader perspective:

• Catch-Up (5,900): This scenario envisions the equal-weight S&P 500 reaching its pre-pandemic high P/E ratio, with the overall S&P 500 trading at a 20% premium due to the tech sector's influence.
• Catch-Down (4,700): This scenario represents a potential correction if current analyst estimates for tech earnings prove overly optimistic. Overinflated expectations could lead to a decline in stock prices.
• Continued Mega-Cap Exceptionalism (6,300): This scenario envisions sustained dominance by tech giants, with the S&P 500 trading at an even higher premium to the equal-weight index, potentially reaching a 45% premium.
• Recession Risk (4,800): This scenario considers the possibility of investor concerns about an economic slowdown leading to a decrease in the P/E ratio and a decline in the S&P 500.

US Elections - Volatility Ahead

The upcoming US election is identified as a potential risk factor, with historical data suggesting increased market volatility before the election. Goldman Sachs maintains its 2024 and 2025 earnings forecasts, expressing some skepticism towards overly optimistic analyst estimates for next year's margins.

Equities typically rally following Election Day as policy uncertainty is resolved.

Their 3-month target remains unchanged at 5,400, reflecting investor anticipation of higher 2025 earnings.

Archive note

This article preserves the analysis in our weekly newsletter sent 21 June 2024. Market prices, forecasts and company circumstances reflect the time of publication and may have changed.

This material is general information, not personal financial advice or a recommendation to trade. Investing and trading involve risk, including loss of capital.