Despite the recent strong rebound of U.S. stocks and the creation of new highs, Goldman Sachs (GS) warns that the space for continued market upside is limited and the risk of a pullback is higher, making the current moment not an ideal time for investors to increase equity risk exposure.
A team led by Christian Mueller-Glissmann, head of asset allocation research at Goldman Sachs, pointed out in a report that according to their research framework, the risk of another market pullback remains elevated, while the potential for further gains is limited. “The risk-reward structure does not support adding to risky assets.” The framework comprehensively considers equity valuations, macroeconomic conditions, and policy catalysts, including risks related to the U.S.-Israel conflict with Iran. Currently, the support from these factors for further market gains is diminishing.
Data shows that the forward price-to-earnings ratio of the S&P 500 has risen back above 21x, while the Citigroup Economic Surprise Index has weakened significantly recently, reflecting reduced support from economic data for market expectations. The Goldman Sachs team stated that valuation-driven downside risks are re-emerging, and the business cycle environment has become less favorable. The firm’s economists have downgraded their assessment of the global growth-inflation mix and expect monetary policy easing to be less aggressive than previously anticipated, with related impacts likely to gradually appear in economic data over the coming weeks.
The report also noted that one of the key drivers of the recent U.S. stock rally has been market bets that a U.S.-Iran ceasefire can hold and that falling oil prices from recent highs will ease inflationary pressures. However, this also means that the stock market is highly sensitive to a re-escalation of geopolitical tensions and a rebound in energy prices. Should the conflict worsen again and drive up oil prices, the market could face a greater shock. Citing options market pricing, Goldman Sachs said traders currently generally see a higher probability of a 10% decline in oil prices over the next month than a 10% rise, implying that if oil prices unexpectedly surge higher, the negative market impact could be more severe.
Goldman Sachs recently issued another warning: due to rebalancing needs in U.S. stock and bond markets, it estimates that U.S. pension funds will be forced to sell approximately $23 billion worth of U.S. stocks by the end of this month, a move that could place significant pressure on U.S. stocks. According to Goldman Sachs’ analysis, this selling pressure ranks in the 83rd percentile relative to all rebalancing flows over the past three years, and when traced back to January 2000, its absolute size reaches the 92nd percentile, indicating a relatively large-scale capital outflow. Goldman Sachs expects this sold capital to be simultaneously allocated to the bond market.
The pressure for market rebalancing primarily stems from the outperformance of U.S. stocks in April. During that month, U.S. equities exceeded fixed income in asset class performance by 8.16%, with the S&P 500 recording a total return of 8.95% compared to a 0.79% total return for 10-year U.S. Treasuries. Additionally, Goldman Sachs noted that weakening demand from futures advisor traders, along with stronger oil prices, has added extra pressure to U.S. stock performance.
