As the fourth quarter of 2024 settles in, the narrative surrounding stocks on Wall Street is starting to shift. This is unsurprising since the beginning of the Federal Reserve’s interest rate cycles stands to change economic conditions in America. These will naturally affect businesses, and cyclical stocks along with financials should see an improved outlook.
For instance, consider two reports by investment bank Morgan Stanley. One of these was released before the interest rate cut, and it covered the bank’s thoughts about the stock market and the US economy for September. The other came in October, after the rate cut. In its September report, MS laid out three scenarios for the flagship S&P index’s performance for the rest of this year. The best case scenario posits that the index would close at 5,650 points in the near term, while the “attractive” and “fair” scenarios predict a closing of 5,200 and 5,350 points, respectively. Yet, the market has outperformed even the best scenario, as its recent reading is 5,764.
The bank also shares that inflation is finally dropping in America. This fact is explained through the S&P’s second quarter earnings performance. In fact, the shifting inflationary trends have set new highs for a decade when we consider sales and earnings surprises for the index according to MS. Its data shows that when inflation was soaring in Q4 2022, the net of positive and negative EPS surprises stood in lowest quintile since businesses struggled with costs. This was despite the fact that during the same time period the net of positive and negative revenue surprises was in the 70% percentile. However, now that inflation has dropped, data for the second quarter earnings season shows that the EPS surprise was in the uppermost quintile (above 80%) while the revenue surprise had dropped to roughly 35%. This data covers the past ten years, and as a result, it illustrates the momentous shifts that the market is undergoing right now.
Since interest rates are the hottest topic on Wall Street, MS also commented on its expectations for them. At the September start, the bank posited that markets were expecting 100 basis points of cuts by 2024 end. The bank shared that it thought “this looks aggressive unless the U.S. economy has a hard landing, but this is not our base case.” With September’s 50 basis points cut out of the way, these expectations have remained unchanged as the CME Fed Watch Tool shows that for the Fed’s November and December meetings, the market has set the probabilities for a 25 basis point cut in each at 85.5% and 82.1%, respectively. These cuts are important for determining the market’s direction, as MS’ data shows that when economic activity as measured by the ISM Manufacturing Index sat at ~67 in 2010, the S&P’s 12 month total return was 30%.
Shifting gears to the October report, MS cautions that while historically equities have outperformed following the first Fed rate cut, elevated valuations, and “consensus forecasting of EPS acceleration rather than decline, equities upside after the first cut may prove more limited this cycle.” The bank’s key stock market insight from its October report comes through its comments about cyclical stocks, though. MS shares that as upward economic growth surprises softened from April through August, “sector and factor trends skewed defensive, consistent with softer economic growth.” However, this might not be the case moving forward, as shown by the Citi Global Economic Surprise Index. MS outlines that this index had bottomed out in August with a ~-25 reading, which had jumped to roughly -12 in September. This trend was mirrored in the difference between global cyclical and defensive sectors, with the reading also moving upward as the economic surprises jumped.
These factors are key when we analyze Goldman Sachs’ list of stocks with the highest expected ROE since the bank believes that stock quality will be determined by economic growth and economic rates. The bank also recently upped its 2024 closing target for the S&P to 6,000 points. This was the fourth revision of its target and a sizeable increase from the previous estimate of 5,600 points. This increase was also accompanied by optimism for the index’s earnings. GS now believes that S&P’s 2025 earnings will sit at $268, for a 4.7% revision from the previous estimate of $256. Its 2024 estimate is unchanged, though, and its value of $241 implies that earnings next year will grow by 11.2%.
As for the next 12 months, GS believes that the S&P will sit at 6,300 points, for an 8.9% growth over its recent value of 5,779. As MS’ data pointed out that EPS surprises are growing as inflation tames, Goldman is also of a similar view. This is because the bank’s chief US equity strategist David Kostin shares that the upward EPS revision is reflective of the fact that the “macro backdrop remains conducive to modest margin expansion, with prices charged outpacing input cost growth.” In a later note, the analyst outlined that “Over the past year, performance of several quality factors has tracked the broad trajectory of market views on growth and monetary policy.” Kostin added that “A positive jobs print could prompt some investors to rotate out of expensive ‘quality’ stocks into less-loved lower quality firms as the market would likely price lower odds of substantial labor market weakening.”
Our Methodology
To make our list of Goldman Sachs’ stocks with the highest consensus ROE, we used the bank’s latest list of 50 such stocks and chose those with a 5% or higher consensus ROE.
For these stocks, we also mentioned the number of hedge fund investors. Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points. (see more details here).
A senior manager studying a market index alongside a team of young stock market analysts.
Uber Technologies, Inc. (NYSE:UBER) is the largest ride sharing services provider in the US. The firm has leveraged its online platform to provide additional services as well such as food delivery. In fact, along with being the largest ride sharing company, the firm is also the second biggest food delivery company in the US after DoorDash. As a result, Uber Technologies, Inc. (NYSE:UBER) benefits from earning from multiple businesses. These also enable the firm to target high growth initiatives such as air taxis, autonomous ride sharing vehicles, and dedicated shuttles. Starting from air taxis, Uber Technologies, Inc. (NYSE:UBER) has invested $125 million into Joby Aviation as of 2020. For autonomous vehicles and shuttles, the firm has teamed up with General Motors to create a robotaxi service, and in October, the firm started a pilot program in New York to ferry users between Midtown New York and LaGuardia Airport. Uber Technologies, Inc. (NYSE:UBER)’s existing market position means that it remains the preferred partner for autonomous vehicles, which could work in its favor down the road.
RiverPark Advisors mentioned Uber Technologies, Inc. (NYSE:UBER) in its Q1 2024 investor letter. Here is what the fund said:
“UBER remains the undisputed global leader in ride sharing, with a greater than 50% share in every major region in which it operates. The company is also a leader in food delivery, where it is number one or two in the more than 25 countries in which it operates. Moreover, after a history of losses, the company is now profitable, delivering expanding margins and substantial free cash flow. We view UBER as more than a ride sharing and food delivery service; we also see it as a global mobility platform with 142 million users (by comparison, Amazon Prime has 200 million members) and the ability to penetrate new markets of on-demand services, such as package and grocery delivery, travel, and hourly worker staffing. Given its $5.4 billion of unrestricted cash and $4.8 billion of investments, the company today has an enterprise value of $165 billion, indicating that UBER trades at 21x our estimates of next year’s free cash flow.”
Overall UBER ranks 5th on our list of stocks with the highest consensus ROE according to Goldman Sachs. While we acknowledge the potential of UBER as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than UBER but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
