Goldman Sachs maintains pro-risk stance as markets continue ‘risk-on’ shift

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Goldman Sachs strategists report that markets have continued their “risk on” shift since the summer, supported by a “Goldilocks” backdrop of optimistic growth expectations within equities (SP500 [https://seekingalpha.com/symbol/SP500]), (COMP:IND [https://seekingalpha.com/symbol/COMP:IND]), (DJI [https://seekingalpha.com/symbol/DJI]) and more dovish Federal Reserve expectations.

Christian Mueller-Glissmann, head of asset allocation research at Goldman Sachs, said that the equity optimism has been “boosted by AI” while the broader economy, especially the labor market, has been weaker, contributing to the dovish shift in Fed expectations.

The current market conditions feature strong performance of the S&P 500 (SP500 [https://seekingalpha.com/symbol/SP500]), large-cap tech stocks (XLK [https://seekingalpha.com/symbol/XLK]), and financials (XLF [https://seekingalpha.com/symbol/XLF]), Mueller-Glissmann said.

“U.S. equity valuations have actually not expanded much as earnings growth has been the main driver of the S&P 500 (SP500 [https://seekingalpha.com/symbol/SP500]) return year-to-date – only in Japan (EWJ [https://seekingalpha.com/symbol/EWJ]) and EM (EEM [https://seekingalpha.com/symbol/EEM]) have 12m forward P/E ratios expanded,” he said, highlighting that good earnings growth, Fed easing without a recession, and global fiscal policy easing will continue to support equities.

Despite the optimistic outlook, the strategist warned of several potential risks including “a growth shock, either due to rising unemployment rate or disappointments on AI,” a rate shock if “the Fed does not deliver on more dovish expectations,” or “a dollar (DXY [https://seekingalpha.com/symbol/DXY]) bear, which hits primarily non-U.S. investors due to U.S. asset dominance in their portfolios.”

However, the strategist believed that “with anchored recession risk we would buy dips in equities into year-end,” suggesting continued confidence in the market’s resilience.

Goldman Sachs maintains a “modestly pro-risk” asset allocation stance, overweighting equities for both three-month and 12-month horizons while underweighting credit in the near term.

According to Mueller-Glissmann, “We prefer the asymmetry of equity vs. credit – in a late cycle backdrop valuations are a more binding constraint for credit while equity valuations can overshoot,” though they are “less bearish credit for 12-month as recession risk remains relatively low.”

Looking forward, the Mueller-Glissmann has set specific market targets, with the S&P 500 (SP500 [https://seekingalpha.com/symbol/SP500]) expected to reach 6,800, 7,000, and 7,200 over the next three, six and 12 months respectively.

The note concludes that while “the volatility reset creates more hedging opportunities,” the current environment suggests that “during ‘Goldilocks’ low vol regimes, we aim to reduce negative carry from hedges and like a ‘risk on’ skew in option overlays,” with Mueller-Glissmann specifically recommending option spreads as “attractive as cheaper downside hedges.”

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