By Risk-on sentiment is back after a brief flight to safety over the summer, and that should support stocks over bonds in the coming months, Goldman Sachs analysts said in a note Tuesday.
They write that the US stock market is set to deliver more attractive returns than bonds as the economy supports higher risk in a late-cycle environment.
A late-cycle backdrop—in which the economy nears its peak and policy eases to prepare for potential slowing ahead—is typically pro-risk, unless growth momentum slows or inflation accelerates to spark policy tightening.
The analysts say the reverse has been true in recent months amid accelerating growth and easing inflation in the US, with strong economic data and policy easing fueling a more risk-supportive environment.
In July, the analysts shifted their rating to neutral on stocks and raised their rating to neutral on bonds after bullish sentiment and slowing growth momentum sparked concerns of a correction, but stocks bounced back quickly, they noted.
“After the summer ‘risk off’, risky assets quickly recovered due to a dovish Fed pivot, China stimulus, and better-than-expected US data,” the analysts said.
The analysts have now returned equities to overweight and credit to underweight, explaining global equities now face lower risks.
“Global equities had a roundtrip and are roughly flat since. Better US data and supportive policy have helped lower downside risks near-term,” they said.
Fed cutting cycles in general tend to support risky assets as long as the economy avoids a recession, the analysts say. Recession risk appears low amid strong labor market data and the Fed’s jumbo 50 basis point rate cut last month, with the odds of a recession in the next year down to just 15%, they forecast.
This risk-on, late-cycle backdrop means stocks will benefit from higher earnings growth and valuations as bonds face downside risks, the analysts say.
“During late-cycle backdrops, equities can deliver attractive returns driven by earnings growth and valuation expansion, while credit total returns are usually constrained by tight credit spreads and rising yields,” the analysts said.
The analysts add that while the current environment supports more risky investments, there remains potential for volatility due to geopolitical conflicts, the US election season and unfavorable moves in growth and inflation.
But even this uncertainty could boost risky assets, they say.
“We think that uncertainty relief could also support risky assets into year-end – this is why we prefer to be long with selective hedges rather than staying neutral equities,” they said.
