Anything For You All: One overlooked market catalyst is spiking to the highest since 2007 — and it could be the saving grace for stocks

One overlooked market catalyst is spiking to the highest since 2007 — and it could be the saving grace for stocks

The US stock market has had a rocky ride in recent days, falling 5.9% last week — its largest weekly decline in more than two years.
Goldman Sachs says an overlooked profit measure that's spiking should underpin a move higher in stocks over the rest of the year.

Amid all the turmoil surrounding President Donald Trump's mounting trade war, the stock market has fallen victim to some sharp selling as traders fear the worst for US corporations.

The benchmark S&P 500 dropped 5.9% over the five days ended Friday, marking its worst weekly performance in more than two years and leaving investors wondering when losses will subside.

But Goldman Sachs is here to put minds at ease. It's focused on an ace in the hole of sorts — a surging driver of higher stock prices that's being overlooked as geopolitical headlines dominate the landscape.

The firm is referring to return on equity, otherwise defined as the amount of corporate net income returned as a percentage of shareholders' equity. By Goldman's forecast, ROE is set to spike to 17.6% this year, which would be the highest level since 2007 — and it has the new tax law to thank.

"Despite market anxiety about trade conflict, S&P 500 profitability remains very healthy," said David Kostin, the chief US equity strategist at Goldman.

The optimism matches Kostin's 2018 year-end forecast of 2,850 for the benchmark, which is roughly 10% higher than where it closed on Friday. And interestingly enough, Goldman's outlook is still 5% below the median forecast of 24 firms surveyed by Bloomberg. The degree of bullishness suggests Goldman is far from alone in its positive outlook, trade war or not.

Based on early trading Monday, it looks as if nerves calmed somewhat over the weekend, allowing investors to focus on core market fundamentals that still look remarkably strong in some areas. Futures on the S&P 500 rebounded 1.4%, while the Dow Jones industrial average and the Nasdaq 100 gauges also climbed more than 1.3% apiece.

And while Goldman acknowledges that S&P 500 valuations are historically high, it argues that the surging ROE will keep them in check and prevent pricing measures from getting overextended.

Goldman also noted that S&P 500 ROE and price-to-book ratio have moved in mostly linear fashion, except for the tech bubble. The big takeaway here is that levels now are right in line with history.

Now that we know how important ROE is expected to be in driving stocks higher, the question becomes: Which companies should I target?

Goldman maintains a basket of high-ROE stocks, spread across all 11 major S&P 500 industries. Here's a sampling of 10 companies the firm counts as constituents, with their 2018 expected ROE growth in parentheses: