Reuters / Brendan McDermid
- The US stock market has had a rocky ride in recent days, falling 5.9% last week, its largest weekly decline in more than two years.
- Goldman Sachs says there's an overlooked profit measure that's spiking, and should be able to underpin a move higher in stocks over the rest of the year.
Amid all the turmoil surrounding President Donald Trump's mounting trade war, the stock market has fallen victim to some sharp selling as traders fear the worst for US corporations.
The benchmark S&P 500 dropped 5.9% over the five days ended last Friday, marking its worst weekly performance in more than two years and leaving investors wondering when losses would subside.
Goldman Sachs is here to put minds at ease. It's focused on an ace-in-the-hole of sorts - a surging driver of higher stock prices that's being completely overlooked as geopolitical headlines dominate the landscape.
The firm is referring to return-on-equity (ROE), otherwise defined as the amount of corporate net income returned as as percentage of shareholders equity. By Goldman's forecast, ROE is set to spike to 17.6% in 2018, which would be the highest level since 2007 - and it has tax reform to thank.
Goldman Sachs
"Despite market anxiety about trade conflict, S&P 500 profitability remains very healthy," said David Kostin, chief US equity strategist at Goldman.
The optimism matches Kostin's 2018 year-end forecast of 2,850 for the benchmark, which is roughly 10% higher than where it closed on Friday. And interestingly enough, Goldman's outlook is still 5% below the median forecast for 24 firms surveyed by Bloomberg. The degree of bullishness suggests Goldman is far from alone in its positive outlook, trade war or not.
Based on early trading Monday, it looks like nerves calmed somewhat over the weekend, allowing investors to focus on core market fundamentals that still look remarkably strong in areas. Futures on the S&P 500 rebounded 1.4%, while the Dow Jones industrial average and Nasdaq 100 gauges also climbed more than 1.3% apiece.
And while Goldman does acknowledge that S&P 500 valuations are historically high, it argues the surging ROE will keep them in check and prevent pricing measures from getting overextended.
As the chart below shows, S&P 500 ROE and price-to-book ratio have moved in mostly linear fashion, with the exception being the tech bubble. The big takeaway here is that current levels are right in line with history.
Goldman Sachs
Now that we know how important ROE will be to driving stocks higher, the question becomes: which companies should I target?
Luckily, Goldman maintains a basket of high-ROE stocks, spread across all 11 major S&P 500 industries. Here's a sampling of 10 companies that the firm counts as constituents, with their 2018 expected ROE growth in parentheses:
- Concho Resources (46%)
- Metlife (43%)
- Comerica (43%)
- Sysco (41%)
- Cisco Systems (40%)
- Charles Schwab (38%)
- Bank of America (38%)
- Phillips 66 (38%)
- MGM Resorts (37%)
- Huntington Ingalls (37%)
Get the latest Goldman Sachs stock price here.