The Three Top Equity Market Themes

Lou Miller, Goldman Sachs' Global Head of Custom Baskets, characterizes the current market as "bulletproof," citing a convergence of supportive tailwinds that have contradicted prior pessimistic forecasts.

• Concerns regarding tariff-driven growth deceleration have not materialized; while tariffs are being passed to consumers, the volume is significantly lower than expected.
• The AI narrative has undergone a rapid positive shift, moving from pessimism three months ago to high optimism, impacting approximately 31% of S&P market capitalization.
• Recent fiscal stimulus via the tax bill has coincided with falling 10-year yields, reinforcing market expectations for an impending rate cut cycle.
• This benign macro backdrop has triggered a historic nine-week rally in the beta factor (stocks with high volatility relative to the market).

Client activity in custom basket strategies is currently driven by three primary themes: AI, policy shifts, and targeted non-U.S. exposures.

• AI-specific baskets focus on "AI winners" and "AI power" sectors, distinct from traditional indices.
• Policy-driven baskets are capitalizing on financial deregulation trends.
• International baskets target specific regions including European defense, German fiscal expansion, Japanese corporate governance reforms, and Chinese AI/humanoid robot sectors.
  • Miller maintains a bullish structural view on U.S. exceptionalism driven by earnings and capital returns, viewing international exposure primarily as a temporary diversification play due to cheaper growth-adjusted valuations abroad.

Regarding market concentration and the AI trade, Miller notes a divergence between breadth metrics and underlying performance trends.

• Traditional breadth metrics appear weak, yet since the local high, non-profitable tech stocks have outperformed mega-cap tech by approximately 25%.
• Miller argues that while high concentration can be detrimental long-term, mega-cap firms leveraged to AI, autonomous driving, and robotics are positioned to outperform over the next five years.
• The "favorite trade" involves betting on the "expectations minus reality" gap: predicting that corporate AI adoption will drive margin expansion and justify current valuations.
  • Companies benefiting from AI-induced productivity gains and reduced labor costs are expected to outperform the equal-weighted S&P over the next 12 months.

Forward-looking statements and immediate market catalysts focus on the upcoming earnings season and tariff policy risks.

• Earnings expectations for the current quarter are low due to anticipated tariff impacts; however, pre-build inventory suggests margins may exceed consensus forecasts.
• Miller anticipates the "left tail" risk of the tariff narrative will be removed by August, though a policy shift remains a potential market risk.
• A rate cut cycle is expected to commence in September, contingent on the resolution of sectoral tariff announcements.