Why the S&P 500 looks increasingly vulnerable to a correction this year, according to Goldman Sachs

• The stock market looks increasingly vulnerable to a sharp pullback, according to Goldman Sachs.
• In a note, the bank highlighted three things that could challenge the bull case for stocks in 2025.
• Strategists pointed to high valuations, market concentration, and the rapid increase in stock prices.

The stock market is facing a handful of risks in 2025 that are boosting the odds investors will see a sharp correction at some point this year, according to Goldman Sachs.

In a note to clients on Thursday, the bank pointed to some factors that are making the market more vulnerable to a pullback. That suggests there's a growing risk of a stock decline, despite bullishness over the prospect of lower interest rates and a soft-landing for the US economy this year.

"Despite the favourable backdrop, the set-up for equities as we enter 2025 is complicated by three main factors," strategists wrote.

Here are three reasons the market looks increasingly at risk of a stock decline, according to Goldman.

1. Stock prices rose rapidly in 2024

The stock market looks like it's "priced for perfection" — and it may not take much to trigger disappointment among investors, strategists said.

The bank pointed to the S&P 500's steep run-up in 2024, with the benchmark index rising more than 20% by the end of the year for the second year in a row.

Over the last two-year period, the benchmark index has seen one of its best run-ups since 1928 — one sign that equities may have limited room to the upside.

"The surge in stock prices in the past two years has been in the 93rd percentile over equivalent periods in the past century," the firm wrote. "While we expect equity markets to make further progress over the year as a whole — largely driven by earnings — they are increasingly vulnerable to a correction driven either by further rises in bond yields and/or disappointments on growth in economic data or earnings."

2. Valuations are stretched

Stock valuations are high, making another year of outsize returns less likely, strategists said.

Rising valuations accounted for a significant portion of stock gains last year, according to Goldman's analysis. In the S&P 493, which excludes the market's top seven tech stocks, valuation increases made up nearly half of all returns.

"Looking at individual markets, the US has a valuation at its 20-year peak, and this remains true even if we exclude the largest technology companies," the bank said. "This combination of performance over recent months and high valuations implies lower returns than in 2024, with earnings the principal driver."

Higher valuations are also drawing attention to the disconnect between stocks and interest rate expectations, the firm said.

Yields have climbed in recent months as traders anticipate higher-for-longer interest rates in the economy. But that hasn't stopped stock prices from moving higher, with the S&P 500 up 6% over the last six-month period.

"Nevertheless, rising equity prices, despite higher bond yields, have resulted in the equity risk premia falling further, leaving little cushion for equities markets in the event of bond yields rising further," strategists added.

3. High market concentration could raise portfolio risks

Stock returns have been highly concentrated in a small segment of the market, making it more likely that investors will react strongly to disappointments in those sectors, Goldman said.

Nvidia, Apple, Amazon, Alphabet, and Broadcom accounted for 46% of the total return in the S&P 500 in 2024.

And while the Magnificent Seven — a group of mega-cap tech stocks that have seen enormous gains in recent years — is expected to notch around 33% earnings growth in 2024, the rest of the S&P 500 is only expected to see 3% earnings growth, per Goldman's analysis.

"The vulnerability of equities to growth disappointments is also heightened because of the increased concentration of equity market returns," strategists wrote.

Goldman isn't alone in its caution over stocks. Fears of a stock market correction are growing on Wall Street, especially as traders eye the risk of higher inflation and more debt turmoil in the US.