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Is Goldman Sachs’ S&P 500 forecast right?


Goldman Sachs NYSE:GS published on Friday a revised year-end target for the S&P 500 index, increasing their previous target of 5200 to 5600 on the grounds of milder-than-average negative earnings revisions and higher valuation multiples.

The researchers argue that earnings-per-share estimates have a typical pattern of negative revisions but those have been offset in part by stellar earnings growth by the five big tech stocks – Facebook parent Meta NASDAQ:META, Google parent Alphabet NASDAQ:GOOGL, Microsoft NASDAQGS:MSFT, Apple NASDAQGS:AAPL and Amazon NASDAQ:AMZN.

Interestingly enough, Goldman Sachs didn’t yet include in this group the much-adored Nvidia NASDAQ:NVDA which has recently pipped Microsoft to the spot of the largest US company with market cap of $3.2 billion.

Now, looking at where the S&P 500 is today, at 5,473, Goldman’s upgrade doesn’t look like very much. It is giving the index an upside of only 2.3% between now and year-end, significantly less than the 15% rise the S&P 500 has achieved in the year so far, which makes us think that researchers at the investment bank will end up revising their numbers once more before the end of the year.

Goldman Sachs’ in-house consensus forecasts imply a 31 percentage-point gap between earnings per share growth for these stocks compared with the median S&P 500 firm (37% vs 6%).

David Kostin, Goldman Sachs chief US equity strategist, writes that the team’s previous forecast assumed a year-end forward 12-month P/E multiple of 19.5x. They now expect the S&P 500 P/E multiple will be 20.4x by the end of 2024.

The researchers have left their 2024 and 2025 earnings estimates unchanged. “Stable S&P 500 earnings estimates are unusual,” Kostin writes. “Historically, starting at June of the previous year, consensus estimates have been cut by an average of 7%.”

Going forward, Kostin expects milder-than-average revisions to S&P 500 earnings estimates until the end of 2024, since upward revisions to megacap tech earnings have already taken place.

Software versus hardware in the S&P 500 index

One of the most interesting shifts at the top of the index is investors tilting away from software companies and more towards hardware makers like Nvidia which will play a key role in the growth of Artificial Intelligence. For AI to achieve the scale it is capable of, companies will need computers and chips on the next level of strength. This would explain why hedge funds’ allocation to software has dipped to multi-year lows, while allocations to semiconductors and other hardware have risen to a five-year high.

Is hardware going to eat software?

Goldman Sachs Research pointed out that several marquee software companies have scaled back their forward-looking guidances for the year. “Software was eating the world in the last decade,” Kash Rangan, a Goldman Sachs Research analyst, writes in a note. “So, is the next decade about hardware eating software?”

In Rangan’s view, the tech industry cycles through a pattern: first by building out infrastructure, then by building platforms to use that infrastructure, and finally by developing applications. “Killer apps” for generative AI are not yet “in clear manifestation today,” Rangan writes, which may explain the relative weakness of the software sector compared with hardware.

The allocations to hardware have spiralled higher largely due to a combination of higher interest rates as well as more mixed earnings revision trends. On the latter point, a number of companies have recently lowered full-year guidances, citing issues that range from macro challenges such as elongating sales cycles to post-Covid normalization with businesses still digesting software spending from the last few years, and finally to the new focus on AI, which will impact near-term spending priorities.

Here’s a selection of related ETF ideas

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WisdomTree Cybersecurity
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This article does not constitute investment advice. Make sure you do your own research or consult a professional advisor.

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