Citing upbeat earnings and a pullback in valuations, Goldman Sachs strategists advise putting more money into stocks for the next three months.
"We continue to think earnings growth remains supportive for equities and following the valuation de-rating and positioning declines since the summer, there is better asymmetry with potential for valuation expansion in the event of rates relief," said a team of strategists led by Christian Mueller-Glissmann.
The strategists are now overweight equities in the U.S. and Asia for the next three months, sticking to that stance for their 12-month view. Their shorter-term outlook on stocks in September was neutral, as they fretted over potential volatility from choppy bond markets, looming midterms and geopolitical stress.
They said the S&P 500 SPX has moved sideways since the summer - the index gained roughly 0.8% from June to August - even amid upbeat earnings. The S&P 500's forward 12-month price-to-earnings ratio stands at 19.1, versus 21.1 in early June and 22 times at the start of the year, according to FactSet.
In short, investors are now paying less for each dollar of a company's earnings. The biggest derating in valuations has been driven by strong tech earnings, notably hardware, though some parts of that sector have also gotten more expensive, said Goldman.
Meanwhile bond yields have been on a tear since late summer, with 10- BX:TMUBMUSD10Y and 30-year BX:TMUBMUSD30Y Treasury yields trading at more than two-decade highs. Mueller-Glissmann and his team said rising yields have particularly weighed on rate-sensitive parts of the stock market.
"Our equity strategy teams continue to expect solid earnings growth into year-end and, while it should moderate in 2027, levels remain healthy - our U.S. team still expects 18% S&P 500 earnings growth in 2027, excluding 'other income' related to revaluation of equity stakes," they said.
The strategists expect the third-quarter earnings season, due to kick off this week, to "surprise to the upside," for the U.S. as well as Europe.
Wall Street analysts expect S&P 500 companies to post third-quarter earnings growth of 29.6%, marking the third straight quarter of S&P 500 earnings growth above 25%, according to FactSet.
"The main near-term downside risk to equities remains higher rates and energy prices -also, U.S. midterm election uncertainty could lead to a pickup in equity volatility from current low levels," added Mueller-Glissmann and his team.
Their portfolio preference right now is a barbell strategy of global tech stocks and rate-sensitive, low volatility, high-dividend bond proxy stocks, which they note have gotten cheaper since summer.
The strategists also shifted to an overweight position on bonds for the next 12 months from neutral in September, though they remain neutral over the next three months. Markets are currently expecting more rate increases than Goldman strategists, who believe limited pressure from nonfood and energy prices will keep a lid on central bank tightening.
"Given our baseline of normalizing inflation, peaking energy prices and more dovish central banks, 10-year bonds should gradually move from headwind to hedge in portfolios," said the strategists. Near term, they prefer shorter duration bonds and are staying overweight cash, such as short-term Treasury bills.
While shorter-term rates are skewed to the downside, they noted that energy-price volatility and monetary policy uncertain remain higher. "The clearest route to a near-term peak in global yields would be tighter financial conditions weakening growth sentiment; recent pressure in corporate and sovereign credit suggests the selloff may already be approaching a speed limit," they said.
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