Goldman Sachs strategists have revised their forecast for the S&P 500 upward, projecting it to reach 5100, up from the previous estimate of 4700. This adjustment comes in light of the continued strength of the stock market. The main driving force behind both changes is the anticipation that interest-rate cuts by the Federal Reserve will provide a boost to the market in multiple ways.
Last week, the Federal Reserve indicated that it may lower short-term interest rates in response to a decline in the rate of inflation. Typically, expectations for short-term rates influence the yields on longer-term government debt. Consequently, the yield on the 10-year Treasury note, which was already under pressure, has dropped from approximately 5% in October to around 3.9%.
The first significant factor benefiting stocks is the decrease in inflation-adjusted yields. Considering the current 10-year yield of 3.9% and subtracting the annual average inflation estimate of 2.21% over the next decade (according to St. Louis Fed data), the real yield diminishes to 1.69%, down from about 2.5% in late October.
Lower real yields inject vigor into the stock market. When secure government bonds become less attractive, investors become more willing to pay higher prices for stocks and their potential profits. Goldman’s revised forecast takes this into account.
According to the bank, by the close of 2024, the S&P 500 is expected to trade at a price-to-earnings multiple of 19.9, based on the combined per-share earnings projected for its constituent companies over the following year. As of Tuesday afternoon, the index was hovering around 4760, trading at approximately 19.5 times earnings.
Goldman Sachs chief U.S. equity strategist, David Kostin, emphasized that “Decelerating inflation and Fed easing will keep real yields low and support a price/earnings multiple greater than 19 times.” These factors contribute to the bank’s revised forecast and optimistic outlook for the S&P 500.
Real Yields and Valuation for Stocks
Having real yields at their current level doesn’t always mean a high valuation for stocks. In January of this year and October of 2022, when the 10-year real yield was around 1.7%, the index’s forward price/earnings multiple was slightly below 19 times.
Expectations of Future Earnings Growth
The market expects earnings to continue growing, providing a reason to invest in stocks now. The economy has been growing at annual rates in the low to mid single digits for several quarters, which supports this expectation.
Impact of Lower Rates on Demand, Sales, and Profits
Lower rates will fuel demand for goods and services, resulting in positive implications for sales and profits. According to Goldman’s model, aggregate earnings per share for S&P 500 companies are projected to grow 8% to $237 in 2024. This growth is attributed to moderate sales growth and buybacks reducing the number of shares outstanding, thereby increasing earnings per share.
Anticipating Further Growth in 2025
Goldman predicts an additional 8% growth to $256 in 2025. If the index trades at 19.9 times that number, it would bring the S&P 500 to 5094.4, just shy of the bank’s target.
Potential Risk of Economic Slowdown
While there is a risk of economic growth slowing down in the coming years, it is a story for another day. Currently, it is expected that the Fed will step aside and support the economy, corporate profits, and stocks.
