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The S&P 500 has entered bull-market territory thanks to a small handful of tech stocks.
Goldman Sachs says that could actually mean good things to come for the rest of the market.
Investors should turn to the stocks that have lagged the latest rally but still have room to rise.
The S&P 500 officially entered bull-market territory late last week. The only question now is, where do stocks go from here?
The index is up just over 20% since hitting its low point in October last year, and has climbed 12% year-to-date. A resurgent tech industry buoyed by AI optimism has dragged the index higher this year, with the five largest Big Tech companies on the market — Apple, Microsoft, Alphabet, Amazon, and newcomer Nvidia — providing an outsized boost to the rest of the market.
But with just a handful of stocks powering the moves higher, investors are beginning to wonder if the bull market is sustainable, or if it's heading for a cliff.
Goldman Sachs analysts led by Chief US Equity Strategist David Kostin set out to answer that question. In a note to clients published earlier this week, Kostin outlined what history says will happen next, where he thinks the market will end the year, and how investors who missed the recent rally can still find ways to profit.
Where will the stock market go next?
In the note, Kostin made it clear that Goldman Sachs thinks this bull market is for real.
While market consensus calls for a 65% chance of recession within the next 12 months, Goldman Sachs economists put it at only a 25% likelihood.
"In this 'soft landing' base case, we forecast S&P 500 EPS will grow by 1% to $224 in 2023, well above the top-down consensus forecast of $206 and slightly above the bottom-up consensus of $221," Kostin wrote. "Following 1Q earnings season, we continue to believe that the worst of the negative revision cycle is behind us, and the trajectory of analyst earnings estimates has indeed improved in recent weeks."
It's no wonder, then, that Goldman Sachs has upped its guidance for where the market will end the year. While the firm's previous guidance called for the S&P 500 to finish 2023 at 4000, Goldman Sachs says it will actually wind up at 4500 — or about 5% higher from where it stands today.
How to invest in today's stock market
At first glance, a small cadre of tech stocks bolstering the rest of the market looks oddly reminiscent of the Dot-Com Bubble of the early 200 0's. Kostin noticed the similarities as well.
"One of our market breadth indicators compares the distance from the 52-week high for the aggregate index vs. the median stock. On this measure, market breadth has recently narrowed by the most since the Tech Bubble," Kostin wrote.
While parallels to a major market crash may give investors pause, Kostin noted that it may actually be a good thing.
In the nine other instances of the market's breadth narrowing down precipitously since 1980, stocks traded sideways for a few months before the rest of the market eventually caught up, with valuations and prices both rising.
The S&P 500 has consistently risen in the months following narrow market breadth.
Goldman Sachs Global Investment Research
Kostin is also confident that, despite higher-than-expected valuations, the market hasn't grown too expensive.
"If economic growth data remain resilient and inflation continues to soften in line with our economists' forecast, a declining equity risk premium will likely offset slightly higher real interest rates and support current equity multiples," he wrote.
That means anyone who missed the latest rally still has a chance to get in on the action. But where should they invest?
Kostin wrote that cyclical stocks have outperformed defensive stocks after the market rally took off. But not all cyclical stocks rode the wave, and the laggards that were left behind still have room to rise.
So, Kostin searched for cyclical Russell 3000 stocks with market caps of $2 billion or more that have trailed the S&P 500 this year. He looked for stocks with a forward P/E of less than 19x, which is the S&P 500's current valuation, and stocks that have improving fundamentals, as measured by YTD expected 2024 EPS revision and growth.
Below are the 24 stocks that Kostin found which have YTD EPS revisions above the median of 9%. Along with each stock is its ticker symbol, market cap, next-12-month P/E ratio, YTD return, YTD 2024E EPS revision, and 2024E EPS growth.
