Goldman Sachs: US stocks are showing a "strong index, weak confidence" pattern; catch-up rally may become the main theme of the next phase

According to Zhitong Finance APP, Goldman Sachs noted that the U.S. stock market currently exhibits an unusual pattern—indices are performing strongly, but investor confidence remains weak. This suggests that the market still has room for further gains, and stocks that had previously lagged behind the leading AI stocks may be poised for a catch-up rally.

The S&P 500 has risen 14% so far this year, but Goldman Sachs’ U.S. Equity Sentiment Indicator has dropped to -0.9, matching the low seen in March. This indicator combines nine measures covering the positioning of institutional, retail, and foreign investors. Goldman Sachs strategist Ben Snider and his team stated in a September 25th report that this reading implies that, if the macroeconomic environment improves, investors still have room to increase their equity exposure.

The weakness beneath the surface of the index is even more pronounced. The S&P 500’s recent trading level is just 1% below the record high in August, but the median stock in the index is 16% below its own 52-week high. Goldman Sachs' preferred market breadth metric has fallen to its lowest level since the dot-com bubble.

For investors, this divergence could be significant if uncertainty around interest rates and economic growth dissipates. Goldman Sachs believes there’s room for both overall market gains and rebounds in lagging stocks, though the unusually narrow market breadth could also result in ongoing volatility for momentum strategies.

Main Index Rises, Valuations Actually Fall

Despite equity prices rising, overall market valuations have come down. The S&P 500’s forward price-to-earnings (P/E) ratio has contracted to about 19x, roughly in line with its 10-year average. Consensus estimates for forward earnings growth are far above the index’s actual gain, which has driven valuations sharply lower from last year’s levels.

Rising interest rates are one reason. Over the course of a month covered in the report, the real yield on the 10-year U.S. Treasury rose by 53 basis points. Goldman Sachs noted that this pace of increase has crossed a threshold that historically has been associated with weaker equity returns.

Goldman Sachs estimates that the S&P 500’s current 19x multiple is about 10% lower than what their model—based on interest rates, inflation, and corporate profitability—would suggest. The strategists do not interpret this discount as evidence of overly pessimistic earnings expectations. Instead, they believe investors are questioning whether the current, unusually high profit levels can be sustained.

AI Spending Boosts Profits, But Its Impact May Fade

This skepticism is especially important as the AI investment boom continues.

Goldman Sachs estimates that hyperscale cloud providers’ capital expenditures will reach $800 billion this year. These expenditures are translating into revenue and profits for semiconductor companies and other AI infrastructure suppliers. The firm estimates that capex from hyperscale cloud providers is accounting for about half of the S&P 500’s earnings growth this year.

But this benefit may not persist at the current scale. As AI capex growth slows and depreciation costs rise, Goldman Sachs expects its contribution to S&P 500 earnings growth to diminish and eventually become a drag. The supply shortages that previously supported semiconductor profit margins will also gradually fade.

This helps explain a seemingly paradoxical phenomenon in the market. Based on recent earnings, equity valuations look reasonable; but over a longer period, profits make valuations appear expensive. The cyclically adjusted P/E ratio based on 10-year earnings is near record highs, below the 1999-2000 peak but above the 2021 level.

The picture painted by free cash flow is less extreme. Goldman Sachs calculates that the U.S. stock market’s free cash flow yield is 3.3%, below the historical median of 4.4%, but in line with other periods in recent decades.

Profitability Drives Valuation Gaps

Corporate profitability has become exceptionally important in determining which parts of the market receive premium valuations.

Goldman Sachs found that nearly all differences in current industry price-to-book multiples can be explained by differences in return on equity (ROE). The relationship between sector profitability and valuations is now one of the strongest seen in decades.

The current ROE for the S&P 500 is about 24%. Goldman Sachs calculates that a 19x forward P/E corresponds to an ROE near 22%, indicating that the market has already priced in a normalization from unusually high profitability levels.

The firm’s analysis also suggests that the recent strength of value stocks may be harder to sustain. Goldman Sachs’s industry-neutral long-short value factor has risen over 25% since mid-2025. However, valuation spreads between individual stocks have narrowed, while Goldman Sachs economists forecast that economic growth will remain stable and near trend. Historically, both of these conditions are less favorable for the value factor.

Investors Shift Focus to Forward Pricing

At the single-stock level, Goldman Sachs has observed a significant shift in investor pricing logic.

The market is increasingly rewarding long-term revenue growth. Investors are assigning an above-average valuation premium to estimated sales growth three years out, while giving less weight to one-year sales growth than usual.

This shift reflects a market that isn’t relying solely on near-term profits to determine long-term value. The AI investment cycle is temporarily boosting some companies’ profits, but AI technology itself could also erode the future earnings of others.

The result is that the market is increasingly focused on a fundamental question: After the current unusual conditions normalize, which companies can continue to grow?

Goldman Sachs Maintains Optimistic S&P 500 Outlook

Despite the risks noted above, Goldman Sachs remains positive on the overall index.

The firm forecasts S&P 500 earnings per share of $375 in 2026 and $415 in 2027. Its S&P 500 target for the end of 2026 is 8,000 points, about 4% higher than the report’s reference level. Its 12-month target is 8,700 points, implying about 13% upside.

Thus, the investment backdrop is more nuanced than the index performance implies. The S&P 500 has risen sharply, yet its valuation multiple has come down. Investor positioning is light, market breadth is historically narrow, while profitability remains exceptionally high.

For investors, Goldman Sachs’ analysis suggests that the next phase of the market may be less reliant on a further re-rating in valuations, and more dependent on whether profits can support those valuations. If macro uncertainty declines, funds on the sidelines and underweight positioning may provide fuel for a broader rally beyond the AI-led stocks. However, persistently high interest rates or a sharper normalization of AI-driven profits could test how mild a 19x P/E truly is beneath the surface.