According To Goldman Sachs, Ai Can Further Boost The S&P 500

The opening of Wednesday's session on Wall Street appears to be slightly weaker, with the rally showing signs of stalling as the upcoming inflation data and Federal Reserve decision loom. Nevertheless, there is some comfort in the fact that the S&P 500 has managed to hold above the 4,200 level, which previously acted as a formidable resistance.

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To reinforce the notion that this level could now serve as a strong support, a group of equity strategists from Goldman Sachs, led by Ryan Hammond and David Kostin, have released a new note that quantifies the impact of artificial intelligence (AI) on businesses and, consequently, the stock market.

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In a summarized overview of their findings, it becomes clear that AI has the potential to provide a boost to the S&P 500. However, there is a significant degree of uncertainty and several important considerations to keep in mind as well.

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Let's begin with how AI can enhance company earnings. According to Goldman Sachs' own economists, AI has the potential to contribute to increased aggregate revenues. This is especially true for companies directly involved in AI development, such as Nvidia, which is renowned for providing computing power. Additionally, companies operating within the generative AI enterprise software market, with a total addressable market of $150 billion, could also benefit substantially assuming a 30% adoption rate.

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Moreover, the widespread adoption of AI has the potential to increase overall labor productivity growth in the United States by 1.5 percentage points over a 10-year period. This occurs as AI frees up workers to engage in other productive activities and those displaced by AI automation find employment within the new AI-driven economy.

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Goldman Sachs states, "Increased economy-wide output could translate into increased revenues and earnings for S&P 500 companies, even beyond those firms directly involved in the development of AI." Consequently, the 20-year compound annual growth rate for S&P 500 earnings per share could rise from 4.9% to 5.4%.

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However, it is important to consider other factors. It is challenging to predict the adoption of transformative technology like AI in its early stages and how much of the resulting profits S&P 500 companies will actually capture. Goldman Sachs economists estimate that AI adoption's impact on productivity growth ranges from 0.3 to 2.9 percentage points annually, depending on the speed of adoption, AI capabilities, and the extent of labor displacement. Based on various estimates of earnings per share growth, the increase in the fair value of the S&P 500 could range from as low as 5% to as high as 14%.

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The potential benefit of AI to the S&P 500 may also be constrained by policy considerations. With profits as a share of GDP already considered "elevated relative to history" and wages as a share of GDP "near a historical low," policymakers may be tempted to prevent excessive rewards for businesses resulting from worker displacement caused by AI. For instance, the effective rate of corporation tax would need to increase from the current approximately 20% to 28% within 20 years to fully offset the projected 11% increase in future S&P 500 earnings associated with widespread AI adoption.

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Furthermore, even if the optimistic earnings scenario materializes, it is unlikely to shield the market from concerns about an economic downturn. Productivity growth typically explains only a small portion of S&P 500 returns.

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For those worried that the current excitement around AI has created a market bubble akin to the dotcom era, Goldman Sachs provides charts demonstrating that while some valuations may be high, they are not currently at extreme levels.

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Yet, for those worried that the current AI excitement has left the market in a dotcom-like bubble, Goldman provides the charts below. Some valuations are high but not at extremes.

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