Goldman Sachs sees a 'risk of a setback in the summer' for S&P 500

Global growth eased in the second quarter, but risky assets including the stock market benchmark S&P 500 continued to perform well driven by expectations of central bank easing and optimism in mega-cap tech.

Goldman Sachs strategists maintain a positive outlook for the second half of the year, anticipating a slight growth increase, inflation normalization, and central bank cuts.

“We continue to think we are in an early late-cycle backdrop, which could last considering a healthy private sector, and as a result both recession and bear market risk have been low,” strategists wrote.

“However, after a strong rally in equities in 1H we see risk of a setback in the summer due to the combination of weaker growth data, already more dovish central bank expectations and rising policy uncertainty into the US elections,” they cautioned.

Thus, Goldman Sachs has shifted to a neutral stance across assets on a three-month horizon but remains mildly pro-risk for 12 months, favoring overweight positions in equities and commodities.

So far, negative news has benefited equities and risky assets due to expectations of central bank easing. Historically, Federal Reserve easing cycles have positively impacted equities as long as growth remained strong. However, "bad news" could turn genuinely negative if there is less monetary policy support or if the negative news becomes too severe, strategists warn.

"A much weaker global growth backdrop, disappointing Q2 earnings season and rising US policy uncertainty can weigh on risk appetite,” they wrote.

Still, strategists expect a higher risk of a market correction rather than a bear market for the second half of the year. Historically, the S&P 500 experienced significant drawdowns only when equities’ cycle growth score fell below zero, typically around recessions.

"With only some growth slowdown, a healthy private sector and a buffer from central bank easing, equity drawdown risk should be limited."

While they do not expect significant equity valuation expansion in their base case, central bank cuts, ongoing AI optimism, and potential growth acceleration in the second half could support valuations, particularly for lagging stocks.

Meanwhile, credit valuations present a greater constraint, with the sector composition seen as “far worse” than equities due to a higher weight in leveraged cyclical/value sectors, Goldman's team noted.