Where Goldman says investors should look for bargains. Hint: the S&P 500 is too expensive
By Isabelle Wang
Goldman sees opportunities in value, profitable growth, cyclicals and small cap stocks.
The S&P 500 index is down 21% since the start of the year, but Goldman Sachs strategists believe it is still too expensive.
The large-cap index started the year with a price-to-earnings (P/E) ratio of 21, a valuation at the 91st percentile since 1980, wrote Goldman Sachs strategists led by chief equity strategist David Kostin. Americans, in a note dated October 14. Although the P/E ratio has since dropped to 15.8, it is still at the 66th percentile.
“Despite elevated recession risk, geopolitical tensions and a generally murky macroeconomic outlook, the earnings yield spread – a common indicator of the equity risk premium – is trading near the tightest levels in 15 years,” the strategist team wrote. “Compared to actual yields on 10-year Treasury bills and investment-grade corporate bonds, the valuation of the S&P 500 Index has ranked above the 75th percentile since 1980.”
However, Goldman strategists still see opportunities in four areas of the US stock market where investors can look for bargains.
Short duration and value stocks
Compared to long-duration stocks, which are particularly sensitive to interest rate fluctuations, value and short-duration stocks look more attractive, Kostin and his team said. “Provided interest rates remain elevated, we expect long-duration stocks to continue to face stronger valuations and returns than their short-duration counterparts,” they wrote.
Valuations and the current macro environment also tend to favor value stocks over growth stocks, as the valuation gap between the most expensive and cheapest stocks in the S&P 500 remains “extraordinarily wide”, according to Kostin.
See: These 11 stocks can cause your portfolio to bounce back from the S&P 500 ‘earnings recession’ and a market bottom next year
Profitable growth stocks
However, the strong sell-off has created opportunities for some profitable growth stocks, which are now trading only slightly above the EV/sales valuation levels that have bottomed over the past 30 years (see chart below). ).
“While higher rates and the risk of recession pose headwinds for near-term growth stocks, the low valuations of some growth stocks could represent an opportunity for stock pickers with long enough investment horizons” , wrote the Goldman strategists.
Some stocks in cyclical sectors trade at depressed valuations even in a recession, according to Goldman’s analysis.
“If recession risk continues to rise and earnings estimates continue to fall, then cyclicals will likely continue to lag,” the strategists said. “However, there is substantial valuation dispersion among cyclicals. Investor fears of recession have weighed on multiples for some cyclicals, meaning that risk distribution is turning favorable even despite the elevated risk of an economic downturn. .”
Small cap stocks
Small-cap stocks trade at much more attractive valuations than large-cap stocks, Kostin and the team said. For example, the S&P Small Cap 600 traded at a P/E ratio of 10.8, the cheapest level in nearly 30 years, according to Dow Jones Market Data.
However, the multiple, which is 32% lower than the main index, reflects concerns over small-cap earnings, which are “extremely high relative to pre-COVID profitability and could face more downside in the recession. than their larger-cap counterparts,” the strategists wrote.
See:Financial markets still underestimating inflation risks despite seven consecutive annual CPI readings of over 8%, DB says
U.S. stocks rallied on Tuesday as investors weighed another round of corporate earnings reports after a volatile week of trading. The S&P 500 climbed 2.3%, while the Dow Jones Industrial Average rose 2% and the Nasdaq Composite rose 2.8%.
(END) Dow Jones Newswire
Copyright (c) 2022 Dow Jones & Company, Inc.