Interview, Other
Why global equities are poised for “fat and flat” returns
- Goldman Sachs Research outlook: The firm projects U.S. equity markets will remain relatively flat in the near term due to high valuations, low profit growth, and attractive alternative yields in cash and interest-bearing assets.
- Year-to-date performance divergence:
- The equally weighted Dow Jones Industrial Average is flat, indicating no broad-based progress.
- The S&P 500 is up approximately 13%.
- The NASDAQ is up approximately 28%, driven heavily by technology concentration.
- The European market (in dollar terms) is up approximately 16%.
- Japan is up 25% in local currency (approx. 13% in dollar terms).
- Recent volatility moderation: Equity volatility has declined recently, reflecting eased fears regarding U.S. debt ceiling passage, regional banking stability, and European energy costs.
- Interest rate cycle status:
- While hiking cycles are nearing an end, rates are expected to rise slightly further (approx. 0.25% in the U.S.) before peaking.
- Rate cuts are not anticipated until the second quarter of the following year.
- The recent decade of negative-yielding debt has ended, shifting the discount rate environment.
- Profit growth expectations:
- Underlying profit growth has been minimal this year; market gains were driven primarily by multiple expansion (valuation increases).
- Full-year U.S. corporate profit growth is projected to rise approximately 5% next year.
- Similar growth (approx. 5%) is expected in Europe, with slightly higher gains in Japan and Asia due to restructuring and recovery.
- Margin compression is expected to persist due to high input costs, including energy and wages.
- Valuation metrics:
- The U.S. S&P 500 trades at a price-to-earnings (P/E) ratio of approximately 19, well above the 20-year average.
- European and Japanese markets trade at significantly lower P/E ratios (12–13x), offering room for multiple expansion, though not necessarily to U.S. levels.
- Significant scope for broad multiple expansion is viewed as unlikely for major global indices.
- Market breadth and leadership:
- Approximately 85% of the S&P 500's return this year was generated by the 15 largest companies.
- The median U.S. company is essentially flat for the year, highlighting extreme dispersion between top performers and the rest of the market.
- Historical data suggests that after periods of narrow leadership (e.g., the 1980s), returns tend to broaden out over the subsequent 12 months as non-leader sectors gain relative performance.
- Generative AI and U.S. exceptionalism:
- While U.S. tech leadership in AI remains a structural advantage, Goldman Sachs argues that AI-driven productivity gains will likely benefit non-tech companies and firms outside the U.S.
- The firm does not anticipate a new decade of U.S. outperformance similar to the post-2008 era, citing narrowed gaps in global profit growth.
- Market cycle positioning:
- Markets are transitioning from the "optimism" phase (valuation expansion) into a "fat and flat" return environment characterized by wider trading ranges and lower average returns.
- This structural shift is driven by higher terminal interest rates, tighter commodity/labor markets, and reduced globalization.
- Shift from TINA to TERRA:
- The investment landscape has shifted from "There Is No Alternative" (TINA) to "There Is a Reasonable Alternative" (TERRA).
- Risk-free assets, such as U.S. dollar cash yielding 5% or more, are now considered viable portfolio components, encouraging diversification across asset classes and geographies.
- Forward-looking catalysts and risks:
- Positive: Avoidance of a recession and the eventual peak/decline of interest rates are viewed as primary tailwinds for financial assets.
- Negative: Residual risks include unresolved regional banking issues, commercial real estate adjustments, and potential winter energy price spikes in Europe.
- Strategy: The firm recommends a diversified approach across regions, sectors, and asset classes to navigate the "fat and flat" environment and capture idiosyncratic (alpha) opportunities.