Odds of an equity drawdown ‘now larger than that of a large rally’: Goldman

Investing.com -- Goldman Sachs strategists see limited upside for equities in the near term, citing elevated valuations and a deteriorating macroeconomic backdrop that could increase the risk of a market drawdown.

The team, led by Christian Mueller-Glissmann, remains neutral on equities over a three-month horizon but maintains an overweight stance for the 12-month view, supported by “structural growth drivers, fiscal and monetary easing, restructuring and high shareholder returns.”

They argue that “equity valuations often tend to overshoot” in late-cycle environments, particularly with negative inflation momentum outside the U.S.

But for the near-term, the strategists caution that “the probability of an equity drawdown is now larger than that of a large rally.”

According to their updated equity tail risk framework, downside risks stem mainly from rich valuations and still-weak leading indicators, while business cycle scores have “modestly deteriorated” and could worsen further in the second half due to tariff impacts and policy uncertainty.

Positioning has turned more bullish since May, especially around U.S. equities and the “Magnificent 7,” driven by renewed AI optimism and easing financial conditions.

However, with narrow market breadth and compressed risk premia, Goldman warns that the recovery in sentiment “might provide more of a speed limit for the current procyclical momentum.”

The team also notes that “a more material deterioration in the growth/inflation mix could result in renewed ‘risk off’ rotation,” especially if macro data surprises to the downside or inflationary pressures rise due to tariffs.

Goldman frames the current macro backdrop as a “Goldilocks” scenario—marked by resilient growth and softer inflation—but warns that this equilibrium may be fragile.

The Wall Street firm warns that investors face “three bears” in the second half that could challenge that balance, including a negative growth shock, a large rate shock, and a deepening dollar bear market.

As equity volatility has reset to lower levels, they see better value in long-volatility and skewed option trades. Preferred hedges include credit protection, dollar downside plays, and upside on China equities.