Goldman Sachs: Small-Cap Valuations ‘Still Stretched’
Federal Reserve Chairwoman Janet Yellen last week said small-cap stocks appeared to be “substantially stretched.” Now, Goldman Sachs (GS) is on board with a similar view.
In a note to clients, Goldman strategist David Kostin said he expects the small-cap Russell 2000 will underperform the S&P 500 over the next 12 months due to pricey valuations and lower earnings forecasts. He cited Ms. Yellen five times in his research note, using her views to bolster his case for caution on small caps.
“Large downward [earnings per share] revisions year-to-date have inflated small-cap valuations, which remain significantly above historical averages both in absolute terms and relative to the S&P 500,” Mr. Kostin said.
In other words, as analysts cut their earnings forecasts on small caps, the Russell 2000′s forward price-to-earnings ratio has gotten pricier. ;The forward P/E ratio for the Russell 2000 index of small shares is 21.3, little changed since the start of the year, but well above its average of 15.8 over the past five years.
“Still-stretched valuations constrain likely returns for small caps,” he added. “Just ask Yellen.”
He predicted the Russell 2000 will gain just 4% over the next 12 months, compared to an outlook for the S&P 500 to gain 6% over the same time frame.
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The muted outlook comes a week after Mr. Kostin ;turned from bear to bull on U.S. large-cap stocks and became one of the more optimistic firms on Wall Street. The firm lifted its S&P 500 year-end target to 2050 from 1900, saying the broad market remained “attractively valued.”
But Mr. Kostin took a more cautious tone on small caps, which have struggled in recent months. The small-cap index earlier this year nearly suffered a 10% correction before bouncing back. It’s down 1% for the year.
“The combination of strong US GDP growth but still-stretched valuation suggests that the Russell 2000 will post a minimal return during the next 12 months,” Mr. Kostin said.
Not every stock analyst has agreed with Ms. Yellen’s assessment of the market. ;Mark Schoenebaum, a biotech and pharmaceuticals analyst at ISI Group, said last week that ;biotech valuations are “roughly in-line with the historical median.”
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Goldman Sachs: Small-Cap Valuations ‘Still Stretched’
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