A higher forecast for the S&P 500

Is hardware eating software? # # --------------------------------------------------------------- The key takeaways today: - Forecast Change: Megacap stocks are likely to help push the S&P 500 higher than expected - Software's dominance over hardware is fading - The US job market may be at an inflection point - Investors need more advanced 60/40 portfolios - The lack of affordable child care is hurting small businesses - Briefings Brainteaser: What special distinction do the first two weeks of July hold for the S&P 500? Was this newsletter forwarded to you? [Sign up now](. --------------------------------------------------------------- Forecast Change: The S&P 500 will rise higher than previously expected Goldman Sachs Research has raised its year-end target for the S&P 500 from 5200 to 5600, driven by milder-than-average negative earnings revisions and a higher valuation multiple. The S&P 500 index has returned about 15% since the start of the year, and earnings and valuation have contributed equally to that return. Consensus earnings-per-share estimates have a typical pattern of negative revisions. That's been offset in part by stellar earnings growth registered by five megacap tech stocks. Consensus forecasts now 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, chief US equity strategist for Goldman Sachs Research, 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. Goldman Sachs Research's 2024 and 2025 earnings estimates remain 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, Goldman Sachs Research 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. --------------------------------------------------------------- Is hardware disrupting the software industry? Even as the AI revolution picks up steam, the software and hardware sectors appear to be sailing in different directions. According to Goldman Sachs' Prime Insights & Analytics team, hedge funds' allocation to software has dipped to multi-year lows, while allocations to semiconductors and other hardware has risen to a five-year high. 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 his team's 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 vis-à-vis hardware. We spoke to Peter Callahan, a technology, media and telecom specialist in Goldman Sachs' FICC & Equities team, about these diverging trends. Why has allocation to software dipped to multi-year lows? There are several moving pieces here, but largely it's 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 from 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) to the new focus on AI, which will impact near-term spending priorities. And in parallel, why has allocation to semiconductors and hardware tech climbed to five-year highs? This is a bit of an inverse image to the dialogue around software. In the early days of this AI platform shift, investors have leaned into the “picks-and-shovels” thematic part of generative AI — the view broadly being that while it's hard to know how the “application” layer evolves over time, as long as we are in the “build” part of this cycle, the hardware and semiconductor layers could stand to benefit. Simply said, investors have been looking for application-agnostic ways to play the AI theme thus far. How have higher-for-longer interest rates affected both these allocation trends? Interest rates are not the only story at play, but in the current higher-for-longer world, investors have been more discerning around a few aspects. These include: (a) longer duration assets, which could characterize many growth assets in software, (b) companies exposed to large, multi-year deals and commitments, where higher costs of capital might drive elongated sales cycles, for example. There are, of course, exceptions to these points. But these are two topics that are coming up as investors navigate a complicated software landscape. --------------------------------------------------------------- The US job market may be at an inflection point After a spike in the first three months of the year, there are growing signs that US inflation continues to cool, according to Goldman Sachs Research. Changes within the job market are a key reason why. With recent consumer, producer, and import price data in hand, our economists estimate that the core personal consumption expenditures (core PCE) price index rose just 0.13% in May, and they expect monthly core PCE to average 0.17% for the rest of the year. This implies that core PCE inflation will end 2024 at 2.7% year-on-year. Both headline and core inflation are predicted to fall to 2% in 2025, Jan Hatzius, Goldman Sachs' chief economist, [writes in the team's report](. One reason for that forecast is that the US labor market is now fully rebalanced. The jobs-workers gap — the difference between job openings and unemployed workers — is back to its February 2020 level. “The normalization has occurred in a very benign fashion, with a large decline in the job openings rate and only a negligible increase in the unemployment rate,” Hatzius writes. For economists, the “[Beveridge Curve]( is a way to visualize the relationship between unemployment and job openings. Since March 2022, the curve has been very steep, meaning job openings fell (from unusually high levels) but there was little increase in unemployment. Now the market is closer to the flat part of the curve, meaning a decline in job openings will likely have a greater impact on unemployment. If so, the job market is at an inflection point. Further significant softening in labor demand would hit actual jobs, not just open positions, and could push up the unemployment rate more significantly. Ultimately, the key driver of labor demand is economic activity, and GDP growth has slowed meaningfully from 4.1% in the second half of 2023 to an estimated 1.7% in the first half of 2024. While Goldman Sachs Research expects a moderate pickup in growth in the second half of 2024, the slowdown, for the most part, is expected to persist. Read [the full report]( which includes our economists' forecast for two policy rate cuts by the Federal Reserve in 2024. --------------------------------------------------------------- Building the portfolio of the future Alexandra Wilson-Elizondo (L) of Goldman Sachs Asset Management and Christian Mueller-Glissmann (C) of Goldman Sachs Research talk to host Allison Nathan on Goldman Sachs Exchanges Against what looks to be a more volatile and dynamic macroeconomic backdrop, investors should construct more “advanced” 60/40 balanced portfolios that include greater diversification across asset classes, styles, geographies, and public and private markets, say Goldman Sachs' asset allocation experts on [Goldman Sachs Exchanges](. “'I think the market will have to price the probabilities of different structural scenarios in the new few weeks and months,” says Christian Mueller-Glissmann, Goldman Sachs Research's head of asset allocation research, whose revised asset allocation framework incorporates structural regimes and how they affect portfolios and valuations. While optimism over AI has driven much of the market's gains this year, the market will likely set a 10% probability of a “super optimistic” Goldilocks AI scenario and a 30% probability of a more moderate AI scenario. “We will learn over time how good it could be, and that narrative is critical for market pricing,” Mueller-Glissmann says. In the meantime, “the macro backdrop is supportive,” says Alexandra Wilson-Elizondo, Goldman Sachs Asset Management's co-chief investment officer of Multi-Asset Solutions. “But we don't think it's going to be as easy in the second half as it's been in the first half, and we do expect [volatility] to go higher.” Investors looking to mitigate potential volatility may consider adding hedges or rotating into other asset classes, say Mueller-Glissmann and Wilson-Elizondo. “The private sector is in very good shape, and that actually increases the ultimate resilience of the economy,” says Mueller-Glissmann. “So we're less worried about the big shocks, but we want to diversify and look at selective hedges. Private markets can be interesting. So I think it's soft hedging.” --------------------------------------------------------------- The lack of affordable child care is hurting small businesses In a tight labor market, small businesses find themselves competing for employees – and the lack of high-quality, affordable child care only exacerbates those challenges, [a survey by Goldman Sachs 10,000 Small Business Voices finds](. Nearly three out of every five small businesses are in the process of hiring employees, either part-time or full-time – but 80% of them are having trouble recruiting qualified candidates for these jobs. Employees are frequently forced to cut their work hours or forgo work entirely because of the high cost or lack of availability of good child care. Some 84% of small business owners believe it's difficult for working parents to afford high-quality care for their children. In the survey, which polled nearly 1,300 participants in 47 US states, two US territories, and the District of Columbia, 62% of small business owners said that being able to offer a child care benefit would help recruit and retain talent. Close to 80% of respondents also said they'd support government efforts to increase federal funding for programs that help families access better child care. This includes the tax credit available to businesses who help locate or provide child care for their employees: 70% of small business owners would support legislation to increase that tax credit from $150,000 to $500,000. --------------------------------------------------------------- Briefings Brainteaser: Midsummer marker The S&P 500 has, on average since 1928, had a distinctive record during the first half of July. What is that distinction? A) Best two-week trading period B) Worst two-week trading period C) Most volatile two weeks of the year D) Lowest two weeks of trading volumes [Check the answer here](. --------------------------------------------------------------- Goldman Sachs in the news By clicking on these links, you will be redirected to external websites that Goldman Sachs does not own or operate. Goldman Sachs is not responsible for the products, services, or content provided on those sites. Please refer to each external website's terms, privacy and security policies for details. [CNBC]( Jun 11 US election "almost certainly will" be a big market event, says Goldman Sachs' Jonny Fine (4:15) [CNBC]( Jun 18 Here's why Goldman Sachs raised its S&P 500 year-end forecast (4:37) --------------------------------------------------------------- --------------------------------------------------------------- Some of the images used in this newsletter are sourced via Getty Images. 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