Author: Ye Zhen, Wallstreetcn
Goldman Sachs partner Mark Wilson recently pointed out that global stock markets are facing increasingly clear upside opportunities before the end of the year. The market has currently fully priced in stagflation risks, and as a more moderate "Goldilocks" economic scenario gradually emerges, investors do not need to wait for the end of the U.S. midterm elections to return to the market and participate in risk asset investments.
Recent market price movements are confirming this optimistic expectation, and the "fear of missing out" (FOMO) brought by AI has returned to the market. After Meta released its Muse product, market expectations for the timeline of AI's large-scale popularization to consumers accelerated significantly, driving AI-themed assets such as the Nasdaq index to achieve a strong upward breakout on Monday this week after three months of consolidation and position reduction following the historic surge in the second quarter.
At the same time, U.S. bond yields are rising again. Unlike the previous competition for funds caused by government and AI capital expenditures, or inflationary pressures caused by energy prices, this round of yield increases is mainly supported by stronger-than-expected data such as the Purchasing Managers' Index (PMI), reflecting the continued strength of U.S. nominal economic growth, and the stock market has withstood pressure and maintained its upward trend despite significant fluctuations in yields.
The market is currently generally worried that the seven-month consecutive rise in U.S. 10-year Treasury yields (the longest streak in fifty years) will eventually drag down the stock market, and investors tend to be willing to increase risk exposure again only after the Gulf situation cools down and the midterm elections pass safely.However, Goldman Sachs' analysis breaks this consensus, pointing out that substantial improvements in the three fundamentals of inflation, economic growth, and corporate earnings are providing a solid foundation for the year-end stock market rebound.
Easing Inflationary Pressures and the Deflationary Effects of AI
For some time, due to the impact of the Iran conflict, rising energy prices have masked the downward trend in core inflation.
But Goldman Sachs points out that the tariff transmission effect is currently weakening, and interest rate hikes and the resulting tightening of financial conditions have produced real effects. If the logistics flow in the Strait of Hormuz returns to normal, energy prices will face significant downside risks, especially considering that Iran's maximum bargaining chip window is expected to end around November 2, and a new deflationary energy narrative could emerge at any time.
More importantly, Meta's Muse product has fired the "first shot" of deflation in the consumer goods and services sector.
Goldman Sachs' research on the "era of commercial agent-based AI" shows that technological progress is substantially reducing costs on the consumer side, which will become a more important deflationary driver than the fall in energy prices.
Cooling Economic Growth Expectations Limit Central Banks' Hawkish Room
Despite facing geopolitical and energy price uncertainties over the past six months, U.S. economic activity has still shown resilience beyond expectations. However, research by Goldman Sachs economist Jan Hatzius shows that this upside risk is weakening, and the second derivative of economic growth will begin to slow.
As fiscal dividends such as tax cuts fade, rising gasoline prices and mortgage rates will hit some economic sectors and consumers.
In addition, although the capital expenditure cycle in the AI field will continue, its growth rate will also slow down. Combined with expectations of falling inflation, the future interest rate hikes by central banks are very likely to be smaller than currently priced by the market.
Mark Wilson emphasized that now is not the time to worry about rising yields; such concerns were only reasonable seven months ago.
Core Earnings Remain Strong, Fundamentals Support Stock Market Valuations
In response to the current intense debate in the market about the sustainability of corporate earnings and "earnings bubbles," Ben Snider, head of Goldman Sachs' U.S. strategy team, believes that some companies currently have "excess earnings," but overall no earnings bubble has formed.
Goldman Sachs reminds investors to note three facts:
First, one should not pay a high premium for record-breaking "other income"; second, memory chips and some semiconductor stocks are indeed currently in a state of excess profitability; third, at least until the end of 2027, even if the growth rate of a company's core earnings slows, it is highly likely to remain particularly strong, which provides fundamental support for stock market valuations.
The stagflation narrative collapses, and the "Goldilocks" scenario reshapes the market landscape
The market had previously been trying to price in a significant slowdown in economic growth and earnings as well as higher interest rates, but the macroeconomic data do not support this perfect "stagflation" narrative. On the contrary, slowing growth, a diminished inflation threat, a softening stance from central banks, and a year of valuation downgrades together constitute a favorable market combination.
Goldman Sachs believes that the current situation is very similar to the bull-bear battle in the market during the period of major technological change in the mid-to-late 1990s.
If what the market ultimately welcomes is a "Goldilocks" scenario (that is, economic growth that is just right, neither hot enough to trigger inflation nor cold enough to cause recession), then the historical data showing a year-end stock market rebound after midterm elections still applies.
Mark Wilson concluded that investors should not wait until the midterm elections are over before taking action, and that as the threat from energy prices fades, European and UK stock markets are also well positioned to participate in this round of gains.
