S&P 500's 8% Gain Hides 12% Median Stock Decline

Goldman Sachs strategist David Kostin has highlighted a significant divergence within the U.S. stock market, noting that while the S&P 500 index has risen 8% this year and is just 1% away from its historical high, the median stock is 12% below its 52-week high. This disparity indicates a notable level of stock dispersion, with certain sectors and companies outperforming while others lag behind.

In an August 8 report, Goldman Sachs revealed that the return dispersion among S&P 500 stocks has reached a historical high, with a three-month return dispersion of 36 percentage points, placing it in the 82nd percentile of the past 30 years. This trend is evident across 11 sectors, with 9 of them experiencing dispersion levels above the 70th percentile.

One of the most prominent trends in the current market is the extreme valuation gap between high-quality stocks and low-quality stocks. High-quality stocks, characterized by high profit margins and strong balance sheets, currently command a 57% premium in terms of price-to-earnings ratio over low-quality stocks. This valuation gap is at the 94th percentile since 1995, reflecting investors' preference for financially stable companies.

Kostin noted that while extreme valuations do not always reliably predict short-term returns, they can provide insights into potential return distributions. Historically, when the valuation premium for high-quality stocks exceeds 40%, the subsequent 12-month return for this factor has never exceeded 10%.

Looking ahead, Goldman Sachs economists predict that U.S. economic growth will slow below trend levels in the coming months, while inflation remains above target. This environment is expected to continue favoring high-quality stocks. However, they also anticipate that current inflation pressures and economic slowdown will be temporary.

Given the current valuation asymmetries, Kostin advises that if economic and earnings growth exceed expectations, investors should be cautious of a potential sudden shift in capital towards low-quality stocks. For investors who are uncertain about the short-term macroeconomic outlook, Kostin has identified 25 stocks that are more likely to be driven by company-specific factors rather than overall economic trends. These "quality-driven" stocks are expected to provide stronger defensive characteristics in an uncertain market environment.