Goldman Sachs has three trading strategies for investors trying to navigate a market it says is “historically overvalued.” The Wall Street investment bank doubts stocks can continue to rise, citing the S&P 500’s historically high valuations on both an aggregate and equal-weighted basis, according to a note last Friday. The broader index trades at approximately 20 times price-to-earnings on an aggregate basis (up from 17 times in October) and approximately 16 times on an equal-weighted basis (up from 14 times). In fact, the S&P 500 is currently at roughly the same valuation that Goldman Sachs expected to end 2024. Goldman Sachs originally expected the S&P 500 to end this year at 4,700, though it has since raised its target to 5,100, according to a CNBC Strategist Survey . The broader index last traded around 4,766. “Our S&P 500 valuation model suggests that the current elevated P/E ratio is appropriate, and we expect the market to trade at roughly the same valuation at the end of 2024,” wrote David Costin. “However, this starting point also suggests that a rating extension is unlikely without a surprising further policy-driven decline in real government bond yields.” That being said, investors looking for value in an overvalued market , have to try three different trades. Costin recommends traders buy small caps; proprietary business with weak pricing power where earnings are likely to improve; and choose consumer goods over utilities. Investors should own small caps this year, Kostin said. The Russell 2000 is expected to rise 15 percent over the next 12 months, compared with an 8 percent gain for the S&P 500, the chief U.S. equity strategist said. In fact, he expects small caps to outperform even if the economy doesn’t grow at the rate Costin expects, with a 2.3% increase in gross domestic product for 2024, given the low valuations of stocks. “The biggest risk is that investors’ expectations for economic growth will deteriorate,” Costin wrote. “However, the low valuations provide a buffer: Based on current valuations, our model suggests that small caps will generate positive returns even if GDP growth in 2024 comes in below our economists’ forecast.” Earlier this month Goldman Sachs predicts that some small caps will beat large caps this year. Among the names that made the list is digital media company Tegna, owner of 64 stations, up slightly this year. It was down about 28% in 2023. Another pick was asset manager WisdomTree, which is up more than 5% in 2024. It jumped 27% last year. Weak Pricing Power Another trade-off is owning businesses with weak pricing power. Not only do they currently trade at a discount to companies with strong pricing power, but they should get a boost as operating margins improve. Operating margin represents what is left of a company’s revenue after operating expenses are paid. “Profit margins should also benefit from operating leverage in an environment of solid economic growth,” Costin wrote. “During periods of improving profitability, investors often reduce the shortfall premium assigned to strongly priced stocks, and firms with less pricing power and more volatile profit margins tend to perform better.” Some companies with weak price power include Freshpet, according to Goldman Sachs’ stock screen. In December, the pet food company was named the best idea of 2024 by TD Cowen, which saw a “clearer path to profitability” for the stock. Freshpet is down 2.5% in 2024, after jumping more than 64% in 2023. Roblox was another stock pick that fell about 13% in January after gaining 60% last year. DR Horton, Texas Roadhouse and Hertz Global Holdings were also recommended. Consumer Staples Meanwhile, consumer staples are attractively valued compared to utilities. Earnings forecasts for consumer staples are near rock bottom, and in addition, the sector tends to perform better during rate cut cycles. “Over the 8 Fed tapering cycles since 1984, Consumer Staples has outperformed the S&P 500 75% of the time by an average of 7 [percentage points] in the 12 months after the first cut. In contrast, Utilities outperformed only 25% of the time, trailing by a median of 4 percentage points,” Costin wrote. Some consumer staples companies that also have weak pricing power include Tyson Foods and Pilgrim’s Pride. Shares of Tyson are up more than 1% this year after falling 10% last year.Pilgrim’s Pride is up 2% this year, adding to its 16% gain last year.
