Goldman Sachs: US stocks still have upside potential, but don't chase the leading stocks; market breadth is at its narrowest since the Internet bubble.

According to Zhitong Financial APP, Ben Snider, a strategist at Goldman Sachs, and his team believe that U.S. stocks can continue to rise with corporate profit growth, but investors should be cautious about chasing recent winners given the unusually concentrated market leadership.

In their October 16 report, these strategists argued that an economic and earnings growth slowdown should suppress stock returns rather than end the current rally. They see better opportunities in previously lagging consumer-facing stocks, supported by the expectation that household purchasing power will improve by 2027.

The warning is hidden beneath the overall market performance. At the time of the report, the S&P 500 index was just 2% below its all-time high, while the median constituent stock was 15% below its own high. Goldman's market breadth indicator is near its narrowest level since the dot-com bubble.

This gap creates challenges for momentum strategies—which favor recent outperformers. Market participation could broaden as laggards recover, or the leading stocks could fall back toward the rest of the market. Either scenario could reverse trades that previously benefited from the old leadership pattern.

Goldman's momentum factor fell 8% in the week the report covered, illustrating how quickly such positions can be unwound.

Earnings Still Provide Support

Goldman predicts S&P 500 earnings per share of $375 in 2026 and $415 in 2027, representing growth of 36% and 11% by their metrics. Excluding one-time accounting distortions, the bank estimates growth of 29% this year and 18% next year. This distinction is important: even if the growth rate slows, the underlying earnings outlook remains robust.

Higher interest rates and oil prices are expected to suppress economic activity. Meanwhile, the earnings boost from AI investments should diminish as spending growth slows and depreciation expenses rise. Goldman estimates AI capital expenditures currently account for about half of S&P 500 earnings growth.

The strategists also believe the room for substantial earnings forecast revisions, which previously supported the stock market, is shrinking. Their forecast for 2027 is close to the analyst consensus, while their forecast of $460 per share for 2028 is about 7% below consensus.

Early third-quarter results offer some initial support for this more cautious outlook. With only 10% of S&P 500 constituents having reported earnings, 53% have beaten consensus estimates by more than one standard deviation, above the 25-year average of 50% but below the four-quarter average of 64%.

Lagging Consumer Stocks Offer Potential Opportunities

Goldman's consumer thesis is based on inflation falling, energy prices declining, and interest rates dropping by 2027. Collectively, these changes should boost inflation-adjusted income growth, especially for low-income households.

The firm forecasts that real income growth for the bottom twentieth of households will accelerate from 0.4% in 2026 to 1.8% in 2027 (measured from Q4 to Q4). Cost of living adjustments for transfer payments in January should provide additional support.

Positioning may help facilitate a rebound. Goldman’s prime brokerage data shows hedge fund exposure to consumer discretionary stocks is at multi-year lows, indicating investors have largely exited the sector.

A Goldman basket of consumer discretionary stocks exposed to low-income consumers has risen 7% since the beginning of October. The strategists also favor companies linked to consumption experiences, citing persistent growth prospects and reasonable valuations.

But this preference is selective. Historically, when economic growth is positive but slowing, the consumer discretionary sector as a whole has tended to underperform.

Stock-Picking Environment Is More Challenging

Goldman’s analysis shows that during past periods of positive but decelerating growth, the S&P 500 has generally continued to rise. These returns are more driven by earnings growth than by investors’ willingness to pay higher valuations.

Such an environment typically benefits companies with enduring growth drivers, improving earnings expectations, and less volatile share prices. Snider’s team expects that as the “profit growth acceleration” trait becomes more scarce, companies exhibiting it will command a premium.

The risk is a deeper slowdown. Rising financing costs have already weighed on economically sensitive stocks and portions of the AI trade, and hedge funds have cut exposure. Goldman's cyclical-to-defensive pair fell 6% in the two weeks prior to the report’s release.

For investors, the bank's view supports continuing to hold equity exposure, but with increased focus on earnings resilience, valuations, and positioning. Further gains are still possible, but the stocks that previously led the market may face a more challenging path forward.