Goldman Sachs' team, led by US equity strategist David Kostin, reports that the recent rebound in "quality" stocks (characterized by high return on equity, low leverage, and stable earnings) is still constrained by elevated short positions and a moderate macroeconomic outlook, which has not provided sufficient impetus for investors to shift back toward defensive and quality stocks. Over the past week, quality indicators rose about 4%, but this slight recovery followed a substantial 17% decline since July, marking one of the most severe downturns in recent years outside of the pandemic. Kostin's team attributed the summer's decline primarily to a vigorous short squeeze and a shift in investor preference toward "low-quality" stocks, which are frequently targeted for short selling. In a report to clients on October 24, the strategists noted, "Since the market hit a low in April, heavily shorted US stock baskets have doubled and have risen over 30% since early September. Quality factors typically underperform during periods of intense shorting pressure, as low-quality stocks tend to be popular short targets."

The macro situation is suppressing quality stock rotation, and Goldman Sachs expects moderate growth for the US economy, with the Federal Reserve likely to continue lowering rates through 2026, which diminishes the relative appeal of defensive, quality stocks. The bank forecasts a 7% earnings growth for the S&P 500 in 2025 and 2026, with a year-end target for 2025 set at 6800 points and a 12-month target at 7200 points, indicating limited upside from current levels. Kostin pointed out that the recent decline in quality factors has exceeded the impact of macroeconomic factors by about 10%, suggesting that the drop is "far beyond what fundamentals alone would dictate." However, Goldman warns that neither economic data nor policy signals indicate a potential reversal in the short term. The report states, "From a macro standpoint... moderate growth and loose policy have not provided sufficient reason for investors to shift back to relatively safe investment choices."

Despite some corrections, valuations for quality stocks remain high. Goldman’s analysis shows that the price of its quality stock basket represents 25 times its expected earnings—over double the 12 times P/E ratio for low-quality stocks. This places the valuation gap near its highest levels in recent years. Within the quality assessment framework, the prices of profitability and low volatility factors remain exceedingly high, while balance sheet robustness appears more reasonably priced. Meanwhile, data from the US Financial Industry Regulatory Authority cited by Goldman indicates that short positions in the S&P 500 remain elevated, with an average of 2.3% of market capitalization sold short—far above historical averages, suggesting that "short squeeze situations may still persist."

Despite overall market pressures, Goldman notes that following recent sell-offs, some quality companies have seen their stock prices discounted. These include members of the firm's quality and quality growth stock baskets, such as Adobe (ADBE.US), Fidelity National Information Services (FI.US), PepsiCo (PEP.US), and S&P Global (SPGI.US), which have all fallen at least 10% from their 52-week highs and trade at P/E ratios below their five-year medians. The median expectation for these stocks indicates an 11% growth in earnings per share by 2026, suggesting that, despite facing overall adverse conditions, some investment opportunities remain for long-term investors.

Earnings Season: Strong Performance, Tepid Reaction As of October 24, 29% of S&P 500 component companies had reported third-quarter earnings, with 69% exceeding analysts' expectations by more than one standard deviation, well above the long-term average. However, the average performance of stocks reporting positive earnings the next day lagged the index by 33 basis points, indicating that strong results have largely been priced in by the market. The coming week will be the busiest period of earnings season, with approximately 44% of the market capitalization of the S&P 500 expected to report, including major tech companies like Microsoft (MSFT.US), Google (GOOGL.US), Meta (META.US), Apple (AAPL.US), and Amazon (AMZN.US). Goldman believes that, due to elevated valuations, strong short positions, and a macroeconomic environment favoring cyclical sectors over defensive ones, the upside for quality stocks in the short term is limited. However, strategists suggest that recent poor performance may offer investors an opportunity to buy selectively in "quality mixed stocks" at more attractive prices. Although the overall potential for a rebound in quality indicators is seen as low, Goldman indicates that some high-quality stocks are currently trading below their fundamental values.