Global stock market valuations are too high! Goldman Sachs: Next year will be an "Alpha" year, with four major investment themes worth paying attention to

As December approaches, 2024 is coming to an end. Looking ahead to next year, how will global stock markets unfold? Where should investors go?

Goldman Sachs Chief Global Strategist Peter Oppenheimer and his team released a report on Monday, predicting that the S&P 500 index will rise 11% from current levels to reach 6,500 points by 2025, with room for growth in Japanese stocks, European stocks, and emerging markets as well.

In this report titled "2025 Global Equity Strategy Outlook: Betting on 'Alpha'," Goldman Sachs paints a picture of a new world characterized by high valuations and high concentration for investors.

Since October of last year, global stock markets have cumulatively risen by 40%, and high valuations imply limited expansion space. Goldman Sachs expects that future index returns will primarily be driven by earnings growth, with a total return on stocks measured in U.S. dollars of 10% by the end of 2025.

In this context, next year will be more about testing investors' ability to pick individual stocks. Goldman Sachs advises investors to focus on "Alpha" in 2025—stocks that outperform the market average—rather than relying on the overall market's "Beta" performance.

The New Reality of the Market: High Valuations and High Concentration

Goldman Sachs' report points out that the S&P 500 index's rise in 2024 is one of the strongest since 1928. Even more astonishingly, the current stock market rally began in October 2023, during which the MSCI Global Index has risen nearly 40% in price alone, the Nasdaq index has climbed over 50%, and Nvidia has surged by 264%.

This remarkable valuation expansion is primarily driven by optimism stemming from cooling inflation and interest rate cuts, with some contribution from corporate profit growth.

However, the current global market valuations have been pushed to historical highs by this optimism, especially in the U.S. stock market, where the 12-month forward price-to-earnings ratio is significantly above the highest and average levels of the past twenty years. Even excluding the major tech giants, U.S. stock valuations remain close to historical highs.

It is noteworthy that despite the Federal Reserve entering a rate-cutting cycle, the stickiness of long-term interest rates has caused a decoupling of bond yields from stock valuations, meaning that the decline in equity risk premium (ERP) can only be explained by an increase in confidence about future growth.

Goldman Sachs forecasts a real GDP growth rate of 2.5% for the U.S. in 2025, higher than Wall Street's consensus of 1.9%, but is more cautious about Europe, predicting an economic growth rate of only 0.8%, also below Wall Street's consensus (1.2%).

Nevertheless, Goldman Sachs points out that the decline in risk premium means that investors' expectations for future growth have already been factored into current stock prices, thus limiting further optimism in the stock market.

Additionally, the unusually high market concentration is also worth noting. Goldman Sachs' report indicates that the U.S. stock market accounts for about 70% of the MSCI Global Index, while the largest 10 U.S. stocks account for over 20% of the total value of the global index.

This highly concentrated market structure, while reflecting the strong performance of these large companies in profit growth, also brings risks. Goldman Sachs warns investors that high market concentration means that the performance of any single large stock will have a significant impact on the entire market

Goldman Sachs: US Stocks Can Rise Another 11%, Japanese Stocks Can Rise Another 17%

However, "the fact that stocks have already risen significantly does not preclude the prospect of further increases," Goldman Sachs' report shows that the median one-year forward return of the US stock market since 1929 is not much different from the performance of the past year.

Given the high starting valuation, the index's performance will largely depend on the pace of profit growth. Goldman Sachs points out that when global stock market valuations are high (currently around 18 times), future 12-month returns tend to be better only when earnings revisions are positive.

Overall, Goldman Sachs predicts that there is still upside potential for global stock markets, as profits are expected to achieve positive growth, especially in the US region.

The report forecasts that in the next 12 months, the S&P 500 index will rise from last Friday's 5949 points to 6500 points, with a total return of 11% in USD. This prediction aligns with Morgan Stanley, where the major bear Michael Wilson recently turned bullish, stating that there is no need to worry about high valuations, and the S&P 500 will reach around 6500 points by the end of next year.

This forecast is based on several key factors: Goldman Sachs is optimistic about US GDP growth in 2025; secondly, if profit growth can exceed market expectations, there is still upside potential for the stock market; against the backdrop of declining interest rates, large companies that performed well during the rate hike period may continue to drive market returns.

For other global markets, Goldman Sachs is more optimistic about the Japanese stock market, predicting:

TOPIX Index will rise from the current level (last Friday's closing price) to 3100 points, with a total return of 17% in local currency;

MSCI Asia-Pacific Index (excluding Japan) will rise from the current level (last Friday's closing price) to 630 points, with a total return of 12% in local currency.

Stoxx Europe 600 Index will rise from the current level (last Friday's closing price) to 530 points, with a total return of 8% in local currency.

However, given the more moderate profit growth elsewhere, Goldman Sachs expects that the global stock market index return will be lower than in recent months, with a total return of about 10% in USD for 2025.

Diversification and Alpha Opportunities—Beyond the Market

In a market environment characterized by high valuations and high concentration, Goldman Sachs suggests that investors should focus more on selecting individual stocks, specifically looking for those that can outperform the market average, known as "Alpha."

Goldman Sachs believes that due to the already high market valuations, future market returns will primarily be driven by profit growth rather than valuation expansion. Therefore, investors need to pay more attention to the fundamentals of companies and seek those with strong profit growth potential.

Goldman Sachs has proposed several specific investment themes: market expansion opportunities, selective value, geographic diversification, and enhanced capital market activities.

Market Expansion Opportunities: Seeking Alpha Globally. Goldman Sachs is optimistic about the Japanese stock market, expecting returns to be primarily driven by earnings growth rather than valuation expansion. Additionally, Goldman Sachs is bullish on the UK, certain emerging markets, and Chinese stock markets, as these regions have relatively low PEG ratios (price-to-earnings growth ratios), indicating potential undervalued investment opportunities.

Selective Value: Finding Value Amid High Growth Expectations. Goldman Sachs believes that in the current market, pure growth stocks have become expensive. Therefore, Goldman Sachs advises investors to seek value within growth stocks, specifically those companies that can offer reasonable valuations and strong growth potential. Goldman Sachs favors a diversified portfolio outside the tech sector but with similar attributes, as well as third-stage AI beneficiaries.

Geographical Diversification: Spreading Risk Globally. Goldman Sachs is optimistic about Japanese, UK, European companies (especially those with revenue exposure to the US), and Chinese stocks.

Enhanced Capital Market Activity: M&A Opportunities. Goldman Sachs expects capital market activity to increase in 2025 due to potential deregulation in the US and strong growth expectations. Goldman Sachs advises investors to focus on companies that may become acquisition targets, a theme that is also applicable in Europe