Investors should disregard talk of market bubbles and stay in the stock market in 2022, according to Goldman Sachs' Investment Strategy Group.
Sharmin Mossavar-Rahmani, the group's chief investment officer, and Brett Nelson, head of tactical asset allocation, predict that the S&P 500 will post a 6.3% return in 2022, representing an abrupt slowdown from the 28.71% return the index delivered in 2021. They still see ample opportunity for investors within that framework, given a low risk of recession, ongoing growth in the U.S. economy and higher corporate earnings.
That forecast assumes that the coronavirus pandemic will be "under control" by mid-2022 and that the surge in COVID-19 variants, including delta and omicron, will abate by the spring of 2022.
"We are very cognizant of the fact that valuations are high and that late 2021 appears eerily similar to early 2000," the executives wrote in their annual outlook report released Jan. 12. "Yet, after careful analysis, we continue to recommend clients remain invested."
The Goldman investment professionals predict the S&P 500 will return 6.3% with a 65% probability. This is slightly above most Wall Street analyst expectations for 2022. An analysis by The Wall Street Journal of forecasts from 13 banks and financial services firms found the average to be a 4.5% increase in the S&P 500 this year.
Following a 4.38% decline in 2018, the S&P 500 has seen total returns of 31.49% in 2019, 18.4% in 2020 and 28.71% in 2021.
Mossavar-Rahmani and Nelson give a 20% probability to a higher return of 12.6% in 2022, a bullish scenario based on assumptions of a faster decline in inflation and higher economic growth, and a 15% probability of a loss of 18.9% this year, a bearish case that assumes more virus mutations, higher inflation and a possible recession.
High valuations
The S&P 500's lofty, recent returns have led to speculation that a bubble has been formed as stock valuations climb. The S&P 500's daily forward price-to-earnings ratio is up about 58% from its March 2020 trough, but remains about 11% below its June 2020 high.
According to Goldman's analysis, equities have been less expensive about 90% of the time in the past 75 years. But this has little bearing on whether a crash is looming, they argue.
The report argues that valuations alone are "not a reliable market timing indicator," pointing out that valuations have been at this historically high level since December 2016 and the S&P 500 has returned 133% over that time. When equity valuations hit similar highs in July 1995, the S&P 500 returned 194% before peaking in March 2000. Mossavar-Rahmani and Nelson note that current valuations are "substantially" below where they were at the height of the dot-com peak in 2000.
Relatively high valuations are also occurring now as the economy is forecast to expand and U.S. corporate earnings are forecast to grow between 8% and 10% on an annualized basis through 2023, they wrote.
Market concentration
Market analysts have cautioned that much of the U.S. stock market's rally has been concentrated among a few mega-cap stocks, but Mossavar-Rahmani and Nelson argue that S&P 500 returns have been far more broad-based.
In 2021, eight stocks — Meta Platforms Inc., Apple Inc., Netflix Inc., Alphabet Inc., Microsoft Corp., Amazon.com Inc., NVIDIA Corp. and Tesla Inc. — accounted for 27% of the S&P 500's market capitalization and returned 39.8%, compared to the large-cap index's 28.7% total return on the year, according to Goldman's analysis. Still, if those stocks were removed from the S&P 500 and the index reweighted, the returns would still have been 24.9% on the year, according to the analysis.
"Strong absolute returns were broad-based across many stocks and many sectors," they wrote, pointing out that the energy sector saw a total return of 54.6% in 2021, the best-performing sector on the year and exceeding the return of the index's eight largest stocks.