The economy is growing at a healthy clip, which has helped propel the stock market to record highs. In a new research note, Goldman Sachs’ David Kostin acknowledges that “a synchronized upswing in global economic activity has helped lift stocks.”
“Although economic data are extremely strong now, an ISM reading above 60 typically marks the peak of growth and presages economic and equity deceleration,” he said. “Since 1980, the ISM has exceeded 60 in eight separate episodes; four of those lasted only one month.”
“Investors buying the S&P 500 at ISM readings of 60 or higher have gone on to suffer negative three- and six-month returns on average as economic activity slowed,” Kostin observed. “In other words, an environment of synchronized global growth acceleration today raises the risk of coordinated global slowdown tomorrow.”
All of this is theoretically sound. Economic growth is most likely to inflect when activity is very strong. And that pace of growth is critical for stocks, which are quick to discount information like this.
“Economic growth is the most important driver of corporate earnings and equity performance,” Kostin said.
Kostin expects the S&P 500 (^GSPC) to slide to 2,400 by the end of the year. Though with all this in mind, he likes growth stocks.
“Companies generating their own earnings growth, such as Information Technology firms and our basket of stocks with the highest Growth Investment Ratios, should continue to be rewarded in an environment of modest economic activity.”
Sam Ro is managing editor at Yahoo Finance.