The U.S. stock market is currently commanding lofty valuations, following two impressive years for the S&P 500. Despite this, Goldman Sachs’ Investment Strategy Group doesn’t see this as a reason to shy away from domestic companies. On Monday, they laid out their 2025 outlook, suggesting a model portfolio for moderate risk investors. This portfolio continues to favor U.S. equities, while reducing reliance on international stocks, and introduces diversification through alternatives like private equity.
FactSet data indicates the S&P 500 is trading with a price-to-earnings ratio of 27.49, which is significantly higher compared to the iShares Core MSCI International Developed Markets ETF (IDEV) at 15.32, and the iShares MSCI Emerging Markets ETF (EEM) at 14.49. While acknowledging the expensive nature of the U.S. market, Goldman doesn’t foresee this becoming problematic in 2025. According to Brett Nelson, head of tactical asset allocation, “Valuations are not a good timing signal,” indicating that there’s no straightforward link between starting valuations and subsequent one-year returns.
In understanding the high valuations, it’s crucial to realize they might negatively impact long-term stock returns, even if 2025 sees no immediate repercussions. Goldman’s equity strategy team in October predicted an average annual return of 3% for the S&P 500 over the next decade, a significant drop from the 13% return of the past decade. One factor underpinning the high valuation is the impressive earning growth rate of major U.S. firms, outpacing those in other developed markets, including Europe. Goldman anticipates this trend to persist in 2025, funneling through to earnings. Sharmin Mossavar-Rahmani, the unit’s chief investment officer, emphasized, “We do think that the earnings advantage that the U.S. has will continue.”
It’s also important to consider the heavyweight presence of tech companies in the U.S. market. These software firms typically enjoy higher valuations than industrial counterparts, regardless of geography. The S&P 500 features a larger proportion of such tech stocks compared to other major markets. Mossavar-Rahmani explained, “Once you make a sector weight adjustment… you actually see that the discount is not as great as it seems.” Essentially, market comparisons need to be made with similar sector weights in mind.
The ascent of tech stocks in the U.S. coincides with a period of rising valuations. Nelson mentioned that there’s been a “structural shift higher” in U.S. valuations post-dot-com boom, partly attributed to enhanced profit margins.
However, a possible impediment in 2025 might be the trajectory of interest rates. Goldman’s outlook anticipates falling yields, supported by three Federal Reserve rate cuts. This prediction was more aggressive than market expectations before last Friday’s strong jobs report, prompting some on Wall Street to speculate that the central bank might have completed its series of rate reductions.
