GameStop’s Reddit-driven surge exposed shocking market vulnerabilities, but overall stock gains won’t be hampered as earnings growth picks up, says Goldman Sachs

• The recent surge in GameStop shares highlights the weak spots in the market, but the disruption will not derail a broader rally in 2021, Goldman Sachs said.
• The phenomenon revealed the ability of retail investors to ignore valuations and prompted new regulatory oversight.
• However, the trend only targeted a handful of small-cap companies, and healthy earnings indicate strong performance going forward.
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GameStop’s recent rally highlights several weak spots in the market’s performance, Goldman Sachs said on Friday. Still, the firm says investors need not worry.

The video game retailer has stabilized at around $ 70 after hordes of retail investors raised the shares and subsequently exited the shares in January. The extraordinary price action sparked regulatory oversight, interest in Congress, and the disruption of global trading platforms.

Since then, the phenomenon has cooled off, leaving Wall Street to ponder what the trend means for markets. The strategists led by David Kostin are mixed. The “epic short squeeze” has put the market structure in the spotlight, and a Chamber of Commerce hearing is sure to address topics such as pay-per-order flow, trade restrictions and short coverage.

GameStop’s explosive rise also reveals that, for the retail investor, the price of a share exceeds valuation by a wild degree. The shares rose as high as $ 483 at the end of last month before quickly reducing earnings. The year-to-date high gave GameStop an implied price-to-earnings ratio of more than 250 times, dwarfing the S&P 500’s 20 times ratio and Tesla’s disputed 170 times implied valuation.

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Retail investors flocking to GameStop might actually believe the company is ready to change quickly, but such an immediate revamp is unlikely, Goldman said.

“Experience suggests that firm makeovers often take time and most investors are cynical until they are convinced otherwise,” the team said.

The trend spread to other very short stocks and fueled massive volatility through January. But retail investors’ grip on the market has been loosened and the S&P 500 hit new highs last week as the GameStop event faded. Additional profits are largely protected from Reddit merchants and their disruptions, Goldman said.

For one thing, fourth-quarter earnings were better than expected. Full-year earnings forecasts have been revised up in all 11 sectors, according to the team. Stocks may rise further through 2021 as vaccine distribution and new stimulus supercharge the US economic recovery.

Goldman expects the S&P 500 earnings to grow 31% in 2021, easily beating the consensus estimate for 22% growth.

The selection of small-cap companies targeted by Reddit merchants pales in comparison to the rest of the market in both capitalization and production, the bank added. The tactics of retail investors initially shocked the establishment. But the overall market rally suggests that the GameStop saga is a sign on the radar, and not the lasting drag that some feared, Goldman said.

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