Goldman Sachs says the US stock market is currently showing an unusual pattern — strong index performance but weak investor confidence — which means the market still has room for further gains, and stocks that were previously left behind by AI leaders could be poised for a catch-up rally.

The S&P 500 has gained 14% so far this year, but Goldman Sachs' US Equity Sentiment Indicator has dropped to -0.9, matching its March low. The indicator combines nine measures of positioning across institutions, retail investors, and foreign investors. Goldman Sachs strategists Ben Snider and his team said in a September 25 report that this reading means investors still have room to increase equity exposure if the macroeconomic environment improves.

The weakness beneath the surface of the index is even more striking. The S&P 500 recently traded just 1% below its August record high, while the median constituent stock was 16% below its own 52-week high. Goldman Sachs' preferred market breadth gauge has fallen to its lowest level since the dot-com bubble era. For investors, this divergence could be significant if uncertainty around interest rates and economic growth fades. Goldman Sachs believes there is room for both broad market gains and a rebound in lagging stocks, though unusually narrow market breadth could also lead to continued volatility in momentum trades.

Index rises while valuations decline

Despite rising stock prices, overall market valuations have actually been digested. The S&P 500's forward price-to-earnings ratio has compressed to about 19 times, roughly in line with its 10-year average. Consensus forward earnings growth expectations are far higher than the index's own gains, driving valuations sharply lower compared to last year.

Rising interest rates are one reason. Over the one-month period covered in the report, the 10-year US Treasury real yield rose 53 basis points. Goldman Sachs says this pace of increase has crossed a threshold that historically has often been associated with weaker stock returns. Goldman Sachs estimates that the S&P 500's current 19x valuation multiple is about 10% below the level implied by its model based on interest rates, inflation, and corporate profitability. The strategists do not interpret this discount as evidence that earnings prospects are overly pessimistic. Instead, they believe investors are questioning whether current abnormally high profit levels can be sustained.

AI spending boosts profits, but the boost may fade

This skepticism is especially important because the AI investment boom is in full swing. Goldman Sachs estimates that hyperscalers' capital expenditure will reach $800 billion this year. This spending is translating into revenue and profits for semiconductor companies and other AI infrastructure suppliers. The firm estimates that hyperscaler capital expenditure contributed about half of the S&P 500's earnings growth this year.

But this benefit may not be sustainable at its current scale. As AI capital expenditure growth slows and depreciation costs rise, Goldman Sachs expects its contribution to S&P 500 earnings growth to diminish and eventually become a drag. The supply shortages that previously supported semiconductor company margins will also see their positive effects gradually fade. This helps explain an apparent contradiction in the current market. Based on recent earnings, stock valuations look reasonable; but when looking at profits over a longer horizon, valuations appear expensive. The cyclically adjusted price-to-earnings ratio based on 10-year earnings is near historical extremes, below the 1999-2000 peak but above 2021 levels. Free cash flow paints a less extreme picture. Goldman Sachs calculates that the US stock market's free cash flow yield is 3.3%, below the historical median of 4.4%, but comparable to levels seen in several other periods in recent decades.

Profitability levels determine valuation divergence

Corporate profitability has become exceptionally important in determining which parts of the market receive premium valuations. Goldman Sachs found that virtually all differences in current industry price-to-book multiples can be explained by differences in return on equity. The relationship between industry profitability and valuation is now one of the strongest in decades. The S&P 500's current return on equity is about 24%. Goldman Sachs calculates that the current 19x forward P/E corresponds to a return on equity of nearly 22%, suggesting the market has already priced in some decline in profitability from abnormally high levels.

The firm's analysis also suggests that the recent strength in value stocks may be harder to sustain. Goldman Sachs' industry-neutral long-short value factor has risen more than 25% since mid-2025. However, valuation differences between individual stocks have narrowed, while Goldman Sachs economists expect economic growth to remain stable and close to trend. Historically, both of these conditions have been unfavorable for the value factor.

Investor pricing perspective shifts to the longer term

At the individual stock level, Goldman Sachs observed a significant change in investor pricing logic. The market is increasingly valuing long-term revenue growth. Investors are assigning above-average valuation premiums to expected sales growth three years out, while placing below-usual weight on one-year sales growth. This shift reflects that the market is no longer relying solely on short-term earnings to judge long-term value. The AI investment cycle has temporarily boosted profits for some companies, but AI technology itself may also erode future earnings for others. As a result, the market is increasingly focused on a fundamental question: after current abnormal conditions normalize, which companies can continue to grow?

Goldman Sachs maintains bullish S&P 500 outlook

Despite the above risks, Goldman Sachs remains bullish on the broader market. The firm forecasts S&P 500 earnings per share of $375 in 2026 and $415 in 2027. Its year-end 2026 target for the S&P 500 is 8,000 points, about 4% above the report's baseline level. Its 12-month target is 8,700 points, implying about 13% upside.

Therefore, the investment backdrop is more nuanced than the index performance alone suggests. The S&P 500 has risen substantially, but its valuation multiple has declined. Investor positioning is light, market breadth is at historically narrow levels, and profitability remains abnormally high. For investors, Goldman Sachs' analysis suggests that the market's next phase may depend less on valuation expansion again and more on whether earnings can support valuations. If macroeconomic uncertainty declines, sidelined capital and depressed positioning could provide fuel for a broader rally beyond AI-driven stocks. But persistently high interest rates or a more dramatic normalization of AI-driven profits could test whether the current 19x P/E is truly as moderate as it appears on the surface.