Markets

    European equity markets have had a strong start to the year, outperforming their peers on the other side of the Atlantic. Even after the rally, Goldman Sachs Research expects European equities to rise as much as 6% in the next 12 months. Strong fourth-quarter corporate earnings, higher defense spending, and a lack of direct tariffs targeting Europe from the US appear to have contributed to the surge in stocks from Paris to Frankfurt. Investors were not positioned for the strong performance, as evidenced by polling from Goldman Sachs conferences: A survey of more than 300 attendees at Goldman Sachs’ Global Strategy Conference in January found that 58% of participants expected US stocks to perform best in 2025. In contrast, only 8% thought that Europe would perform best, making it the least favored developed market. We spoke with Goldman Sachs Research Senior Strategist Sharon Bell about what might be behind the rally in European stocks and her forecast for the rest of this year. How much of Europe’s outperformance this year comes down to low expectations? Investors were very skeptical about Europe going into this year — on the economy, on the impact of Trump policies and tariffs, and on growth. Because markets had already priced in a fairly weak growth profile this year, Europe only had to perform in line with expectations (or slightly better) and it could do very well. The recent strong performance has been driven by proposals from Germany to spend more on infrastructure and defense, and in doing so bypass the restrictions of the debt brake. This is a huge change for Germany and for Europe, which has historically been reluctant to spend to boost growth. In addition, some of the strong performance is because the fourth-quarter company earnings season was reasonably good for Europe. And some of it is also that Europe so far hasn’t been targeted with tariffs by the US. Stocks have also risen because of the growing understanding that Europe will have to spend more on defense: If there’s no peace in Ukraine, Europe spends more on defense; if there is peace in Ukraine, Europe has to ensure that peace and therefore spend more on defense. Either way, Europe spends more on defense, which helps defense companies. How far has the valuation gap between US and European stocks closed? US equities were at extremely high valuations at the beginning of this year. The US market is down a bit, meaning that US valuations have also come down — although they’re still in the 90th percentile of their historical range. Meanwhile, European valuations have increased, and are now above the 50th percentile. Why is that? Because the European market, in absolute terms, has risen 10-12%, and earnings have not gone up — if anything, earnings-per-share estimates for this year are slightly down. The US has gone down a fraction, and Europe’s gone up a fraction. So that elastic band that got stretched very far between US valuations and European valuations has come back in a tiny bit. It’s still very stretched, though — not because Europe is very cheap, but because the US is still near historically high valuations. Is there more room for European stocks to rise? I do still see upside for the remainder of this year: Our 12-month target still has 5-6% upside. But the market’s already up 10-12% since the start of the year, so I feel we’ve already had a lot of the returns on European equities. Markets move in front of data and economic news. The economic news for 2026 and 2027 has got better for Europe: Our economists now expect German real GDP to expand 2% in 2027, mostly because of more government spending. That’s a large change from a flatlining economy in recent years. But the market priced that news in quite quickly. It could be, because markets are volatile, that stocks come down a bit, get to a lower base, and then rally again. I do see a little bit of medium-term upside, because I think we’ll have positive earnings growth for the next few years, but that growth is unlikely to be very strong for Europe. We’ve seen some early signs that could indicate weaker US economic growth. How could that impact European equities? I think part of the sell-off that we’re seeing at the moment in US equities is a reflection of people reassessing the impact of this trade policy uncertainty. And it does look like it’s quite negative so far for the US economy — particularly for the consumer. We’ve seen consumer survey data on inflation expectations zoom up in the US. Around a quarter of European companies’ exposure is to the US. So in the end, if the US economy is not growing as fast as people expect, then Europe won’t export as much to the US. Many of the European companies with direct exposure to the US aren’t really exporters — they don’t produce in Europe and then send over to the US — instead, many of them actually own US businesses or divisions. So in a sense, there’s two ways in which weaker US economic growth would hit European companies: It would affect exporters themselves (and that in turn impacts European GDP), and it would also hit European companies with US businesses. Having said all of that, we still expect reasonably healthy US growth this year. And if growth does weaken further, then with interest rates at the level they are, there’s always potential to soften financial conditions by bringing rates down. We don’t expect a recession in the US, but a slightly softer patch of growth is not so good for European companies, either. What sectors look well positioned for growth in Europe? Defense stocks have done extremely well recently. A basket of European defense stocks is up 67% since the start of this year (as of March 6). But that strong performance is partly based on future expectations. I think those stocks will probably

   US stocks have been buffeted in recent weeks. Goldman Sachs Research reduced its forecast for the S&P 500 Index to reflect our economists’ estimates for slower GDP expansion, higher tariffs, and an overall uptick in uncertainty. The S&P 500 is expected to rise to 6200 by the end of the year, down from an earlier forecast of 6500. This suggests an increase of about 7% in the price of the index during that period (as of March 25). The team also reduced its forecast for S&P 500 earnings-per-share growth to 7% from 9%. Goldman Sachs Research estimates that the average company in the index will make $262 of profit per share this financial year (compared with $268 previously). “The headwinds to equity valuations from a spike in uncertainty are typically relatively short lived,” Goldman Sachs Research Chief US Equity Strategist David Kostin writes in the team’s report. “However, an outlook for slower growth suggests lower valuations on a more sustained basis,” he says. What’s the outlook for stocks in a recession? Kostin adds that portfolio managers are increasingly asking about the implications of a potential recession on the US equity market. During 12 economic downturns since World War II, the S&P 500 typically declined by 24% from its peak, while earnings dropped by 13% (median peak-to-trough). History shows that short-term peak-to-trough declines in stocks, or drawdowns, are usually good buying opportunities if the economy and earnings continue to grow, according to Goldman Sachs Research. Over the last 40 years, the S&P 500 index has experienced a median yearly drawdown of 10% — that’s in line with this year’s earlier 10% decline. Our economists assign a 20% probability of recession during the next 12 months, slightly above the unconditional historical average of 15%. In contrast, the consensus of economist estimates assigns a 25% likelihood of recession. “The key market risk going forward is a major further deterioration in the economic outlook,” Kostin writes.  What caused the stock market to drop? The immediate causes of the market decline included an increase in policy uncertainty (largely driven by tariffs), concerns about the economic growth outlook, and investors — particularly hedge funds — unwinding their positions. Goldman Sachs Research economists recently revised their expectation for the average US tariff rate, which is now projected to rise around 10 percentage points to 13%. The US stocks team’s rule of thumb is that every five-percentage-point increase in the US tariff rate reduces S&P 500 earnings per share by roughly 1-2%, assuming companies are able to pass through most of the tariffs to consumers. Similarly, early indicators of weaker-than-expected economic activity in the US affect the outlook for the stock market, because weaker economic growth usually translates to weaker corporate earnings growth. Goldman Sachs Research economists recently lowered their forecast for real US GDP growth to 1.7% year-on-year by the end of the 2025 financial year, down from 2.2% previously. The market decline also reflects a major unwind in positioning, especially among hedge funds. Goldman Sach Research’s basket of most-popular stocks among hedge funds has suffered its sharpest period of underperformance relative to the S&P 500 in five years. And more than half of the S&P 500 index’s 10% drop from its all-time high in February came from a selloff of the large US tech companies known as the Magnificent Seven.  Which stocks should investors buy? To protect their portfolios, Kostin’s team suggests that investors favor \”insensitive\” stocks that are insulated from the major themes driving fluctuations in the markets. For example, investors can screen for the stocks with the lowest recent sensitivity to the equity market’s pricing of US economic growth, trade risk, and artificial intelligence. Additionally, Kostin writes, “investors should consider stocks hammered by the hedge fund positioning unwind that trade at discounted valuations.” In particular, he highlights stocks that are popular with hedge funds that have declined by more than 15% from their highs and trade at or below their three-year median price / earnings multiple. For the stock market to recover, Kostin writes, one of three things needs to happen: An improvement in the outlook for US economic activity, either due to better growth data or more certainty around tariff policy Equity valuations that price economic growth well below Goldman Sachs Research’s baseline forecast Investor positioning falling to depressed levels

    Recent declines in US stocks were driven by high investor expectations at the beginning of the year as well as concerns about weaker economic growth and uncertainty created by President Donald Trump’s tariff announcements. Even after the drop, the S&P 500 might be vulnerable to deeper declines, according to Goldman Sachs Research. US stocks fell in early March, with the S&P 500 posting a correction (a drop of 10% or more from peak to trough) as of March 27 after reaching an all-time high on February 19. In spite of the steep selloff, our strategists’ equity drawdown risk model, which forecasts the probability of the S&P 500 falling, suggests US stocks are at risk of further declines. The model has indicated an elevated risk of the equity losses since January. “The equity drawdown probability hasn’t peaked yet,” says Christian Mueller-Glissmann, head of asset allocation research within portfolio strategy for Goldman Sachs Research. The model looks at both macroeconomic and market variables, and those factors do not appear to have reached a point of balance. “As the markets have gone down, the macro backdrop has also deteriorated. And that means that you cannot sound the all-clear at this point. There’s still a risk of the equity correction continuing — even though we do not expect a bear market, as this usually requires a recession,” he adds. But Mueller-Glissmann also notes that the equity drawdown model is unlikely to anticipate changes in policy, such as adjustments to interest-rate policy from central banks. “So if there’s a major policy pivot from President Trump or the Federal Reserve, of course, markets could recover much faster.” Why did US stocks fall? Mueller-Glissmann’s team looks at three different cycles in its analysis of markets: the sentiment cycle, the business cycle, and the structural (economic) cycle. Sentiment has been particularly important in stock markets so far this year. The structural cycle, which describes trends in the wider economy, is often closely linked to the business cycle — the performance of the economy and companies. But sentiment — the attitude of investors towards a certain stock, sector, or market — is often behind short-term market movements. The performance of equity markets has defied the expectations of many investors, both because of the decline in US stocks and because of the relative outperformance of European and Chinese stocks. “This reversal was accelerated and exacerbated by the sentiment going into 2025” Mueller-Glissmann says. “Positioning was very bullish at the beginning of this year with regards to the US. The reverse was true of Europe and China: People were structurally bearish because of headwinds from housing, demographics, and geopolitical concerns in China, and because of political gridlock and lower productivity in Europe.” The correction in the US, meanwhile, has been led by the major large cap technology stocks known as the Magnificent Seven, which have dropped significantly more than the rest of the S&P 500 Index. “That’s important, because the Magnificent Seven are also drivers of confidence for retail investors (i.e. for households). We find that household allocation to equities in the US is the highest ever — even higher than during the tech bubble,” Mueller-Glissmann explains. This means that sentiment in the US equity market might be particularly sensitive to a drop in the value of Magnificent Seven stocks. One way of assessing investor sentiment is by looking at risk appetite as indicated by markets. “What we’ve found historically is that if our risk appetite indicator is very negative, irrespective of what happens in the business cycle, at some point you can buy the dip,” Mueller-Glissmann says. Normally, the risk appetite indicator needs to register close to -2 before investors can expect a reversal in market performance without a change in the momentum of the wider economy or policy support. And while the indicator is currently well above that level, things can change quickly. A good example was during the summer in 2024, when the risk appetite indicator fell to -2 in a matter of days after the start of the equity downdraft, creating a good buying opportunity for investors, who could look for a market recovery shortly after. “Normally, when we have an equity correction, I’m looking either for the risk appetite indicator going to -2 or our equity drawdown risk model — which incorporates macro momentum, policy shifts, and also the risk regime — starting to peak. We don’t have either yet. And that tells us that, in the near term, things could remain quite bumpy,” Mueller-Glissmann says. What’s the outlook for the 60/40 portfolio? At the beginning of the year, when the equity drawdown risk indicator was suggesting an elevated risk of a correction in US stocks, the portfolio strategy team cautioned that investors should diversify portfolios both across and within assets. Diversifying across assets means balancing out equity exposure with bonds; diversifying within assets means investing in equities from non-US markets. But Mueller-Glissmann adds that the 60/40 formula for buy-and-hold portfolios — comprised of 60% equities and 40% bonds — has continued to perform well so far this year. “Equities are down in the US, but bonds have rallied in the year to date. And in Europe, bonds are down, but equities have rallied,” Mueller-Glissmann says. This means that an average portfolio comprised of both assets from either region was diversified enough to keep yielding returns in spite of the volatile start to the year. How to invest amid signs of economic slowdown Historically, it’s unusual for non-US equities to decouple from their US counterparts, Mueller-Glissmann adds. This means that a continued decline in US stocks could start to affect global equities more broadly. “What tends to happen is, maybe on the first instance as US equities sell off for the first 5-10%, European and global equities can outperform, like they have for the last few weeks,” Mueller-Glissmann says. “But then, if US equities go through a larger correction, the rest of the world tends to catch down.” “As a result of that, you

    Stocks around the world have recently traded in and out of a bear market — usually defined as a 20% decline from their recent peak. Peter Oppenheimer, chief global equity strategist in Goldman Sachs Research, writes that the history of bear markets can offer clues about the duration and severity of these downturns. US stocks rallied recently after President Trump announced a 90-day pause on the additional country-specific portion of the “reciprocal” tariff. But Oppenheimer suggests that the conditions for a sustained rebound aren’t yet in place. “Valuations need to adjust further before equities can transition into the \’hope\’ phase of the next cycle — the powerful rebound that typifies the transition into a new bull market,” Oppenheimer writes. What can we learn from previous bear markets? The team finds that there are three distinct categories of bear market. Firstly, structural bear markets, like the Global Financial Crisis in 2007-2008, are triggered by structural imbalances and financial bubbles. Often, these events are associated with a price shock such as deflation and are followed by a banking crisis. Secondly, cyclical bear markets are a function of the economic cycle, which rises and falls. They’re triggered by, for example, rising interest rates, impending recessions, and declining profits. The last category is event-driven bear markets, which are triggered by a one-off shock that either doesn’t lead to a recession or temporarily knocks an economic cycle off course. Common triggers are wars, an oil price shock, a crisis in emerging markets, or technical market dislocations. An example of an event-driven bear market is the downturn during the Covid pandemic. The economy was reasonably balanced when the pandemic hit, with both economic growth and inflation at low, stable levels. The recovery for markets hit by event-driven downturns tends to be short-lived, and the recovery is usually rapid. The average cyclical and event-driven bear markets generally tend to fall around 30%, although they differ in terms of duration. Cyclical bear markets last an average of around two years and take about five years to fully rebound to their starting point, while the event-driven ones tend to last around eight months and recover in about a year. Structural bear markets have by far the most severe effects. The average declines are around 60%, playing out over three years or more, and they tend to take a decade to fully recover, Oppenheimer writes.    “Of course, identifying the type of bear market is easiest in retrospect but more complicated in real time,” Oppenheimer writes in the report. A bear market may begin as one type and then transform into another. How severe was the recent market downturn? Oppenheimer’s team points out that the latest market decline was event driven, triggered by the sharp rise in tariffs announced by the US. The strong prospects for global economic activity at the start of the year reinforce this view. “However, it could easily morph into a cyclical bear market given the growing recession risk,” Oppenheimer adds. Goldman Sachs Research’s economists have lowered their US GDP growth forecasts for 2025 and have indicated an increasing risk of recession. Both event-driven and cyclical bear markets have an average stock market decline of around 30%, but event-driven downturns tend to be shorter and recover more quickly.  Goldman Sachs Research’s equity bull/bear indicator, which helps to identify potential downturns in stock markets, remains high as of April 8, signalling an increased risk of the market falling. With valuations for US stocks still high, and unemployment very low (and therefore at risk of rising), there is further room for US stocks to fall, Oppenheimer writes. What will it take for stocks to recover fully? Looking at bear markets since the 1980s, the team sees a pattern of rebounds before the market typically reaches a trough. Looking at 19 global bear market rallies since the early 1980s, the team finds that they have lasted an average of 44 days and the average return of the MSCI AC World Index has been 10-15%. “Given the very sharp falls in investor sentiment over the past few days, it would be typical for there to be a bounce in equity prices,” Oppenheimer writes. Most bear markets recover fully within a year. Oppenheimer’s team is looking for four signals before it expects to see a sustained rebound in stock prices: Attractive stock valuations Extreme positioning (investor portfolios signal so much pessimism that a repositioning of their holdings becomes more likely) Policy support A sense that the second derivative (the rate of change of the rate of change) of growth is improving In practice, stock valuations are still relatively high by historical standards — especially in the US, where stock market capitalization was at a record-high valuation relative to GDP before the downturn. Interest rate cuts, which also play a big role in helping bear markets to recover, do not seem to be imminent at this stage. However, our economists think that could change if a recession becomes more likely. Economic growth momentum seems unlikely to accelerate significantly in the near term, with higher-frequency survey data remaining weak. Additionally, market sentiment and investor positioning of portfolios are shifting towards more negative levels, with Goldman Sachs’ risk appetite indicator registering one of the largest two-day drops since 1991 following the latest tariff announcements. As mentioned earlier, an event-driven bear market can morph into a cyclical one if it triggers a recessionary outcome in which company profits fall. But the current downturn doesn’t have the characteristics of a severe structural bear market. “Broadly speaking, the corporate sector has healthy balance sheets and banks are well capitalised. Equally, while equity valuations are high, particularly in the US, they have not been in bubble territory, in our view,” Oppenheimer writes. “This makes us more confident that this bear market will be more modest in depth and duration than previous structural downturns,” he adds. What’s the outlook for non-US stocks? US stocks have consistently outperformed their peers for nearly 15 years, leading to high valuations. But the recent