Worried about a bubble? Why you should overweight U.S. equities this year, according to Goldman Sachs

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According to the Investment Strategy Group at Goldman Sachs, investors should favor US equities this year, even if valuations are historically high and the Federal Reserve moves to tighten its monetary policy.

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Sharmin Mosawar-Rahmani, chief investment officer at Goldman’s consumer and wealth-management division, said during a media briefing on the group’s 2022 outlook on Thursday, “It’s not really effective to use valuations as an exit signal from equity. “, Undoubtedly, investors run the risk of missing out on larger returns by exiting the market due to concerns over higher valuations, he added.

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Consider the S&P 500 Index, which measures the performance of US large-cap stocks. It entered the 10th decade in December 2016 for equity valuations seen in the post-World War II period. However, since that time, the index has produced an overall 133% return through 2021, despite expensive stock-market valuations, Goldman’s investment strategy. The group said in its Outlook report.

While many investors point to similarities between today’s US stock market and the dot-com bubble of late 1999, Goldman sees important differences, including the width of the rally, According to Mosawar-Rahmani.

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To be sure, the S&P 500 is concentrated in a small group of stocks — Meta Platforms Inc. fb,
-2.03%,
Apple Inc. AAPL,
-1.90%,
Netflix Inc. nflx,
-3.35%,
Google Original Alphabet GOOG,
-1.78%,
Microsoft Corporation MSFT,
-4.23%,
Amazon.com Inc. AMZN,
-2.42%,
Nvidia Corp. Nvda,
-5.09%
and Tesla Inc. TSLA,
-6.75%
Goldman pegged the group to represent 27% of the index’s market capitalization, but also pointed to strong returns for the index last year that were broader.

S&P 500 spx FactSet data show, gave an overall return of 28.7% in 2021. But even after excluding the group of eight stocks, which Goldman highlighted as a large weighting collectively in the index, returns would still have been higher at 24.9%, the investment strategy group said.

“This bull market is not driven by just a handful of stocks,” the Goldman report said. “Returns were much more skewed in 1999 than in 2021.”

The report shows that in 1999, the S&P 500 index returned 21%, while an equal-weighted version of the index gained 10% and the average stock returned just 1%.

In addition, the equity risk premium, a measure of the S&P 500’s earnings yield relative to the yield on a 10-year Treasury note, was “significantly less attractive in 2000,” according to the report.

Yield on 10 Year Treasury Note TMUBMUSD10Y,
1.703%
It has already climbed about 21 basis points in January. The Fed released minutes of its December meeting earlier this month, showing that it was being more aggressive than expected to take possible steps toward tightening its monetary policy to fight high inflation.

Consumer prices rose 0.5% in December and inflation hit a nearly 40-year high of 7%

Goldman’s investment strategy group said they expect at least three interest rate hikes by the Fed in 2022, with more likely to come, due to higher inflation or faster growth. But “in the event of global disruption, including a resurgent pandemic, rates may be raised slowly or not at all.”

According to the report, under their base case scenario, Goldman expects the S&P 500 index to deliver an overall 6.3% return this year.

Regarding Goldman’s recommendation to weigh more than US equities, Mosavar-Rahmani said, “America’s primacy is not going to disappear.” The US maintains an edge in innovation, he said, citing the high productivity of its labor force and relatively strong corporate earnings growth.

Of course, the US stock market could be volatile in 2022, with the potential for a “downdraft” at any time during the year, Mosavar-Rahmani said. But the risk of a recession is low, she said.

Goldman expects global growth this year to be 4.5%, which according to the report is “far above trend”. The report shows that should the US economy expand to 3.9% in 2022, unemployment will fall to 3.1% by the end of the year.

The COVID-19 pandemic is a “top risk” for Goldman’s view. According to Mosawar-Rahmani, the supply-chain bottlenecks that have stoked inflation in the pandemic should eventually ease this year as companies seek to adjust to constraints.

People are moving up supply chains from China to other parts of the world, something that began even before the pandemic, “some of it came back to the US or moved to Mexico,” she said.

Meanwhile, inflation will probably remain high this month and into February, potentially reaching peak levels, and then gradually begin to fall in 2022, according to Mosavar-Rahmani.

“There are a lot of risks out there,” she said, “but we think we can navigate them.”

On Thursday, the stock closed lower and the Nasdaq Composite hit a three-session recovery as investors sold shares of Big Tech companies.

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