Innovation dividends continue to support equities, but inflation and high valuations require stronger portfolio balance

Overview

The report assesses global asset allocation from the perspectives of the business cycle, growth and inflation, market pricing, risk appetite, valuations, earnings, and long-term structural cycles. The war in the Middle East has worsened the recent growth-inflation mix, shifting markets from a “Goldilocks” environment toward reflation pricing, but the report expects the macro environment to improve as inflation gradually normalizes. Equities remain supported by earnings and the innovation cycle, although technology weights, index concentration, and valuations are already elevated, and rate shocks and inflation volatility make the diversification effect of a traditional 60/40 portfolio unstable.

Core views

The report’s core view is that investors should not exit substantially late in the cycle simply because valuations are high, but nor should they simply chase technology momentum. Equities remain relatively attractive over the next 12 months, supported by earnings resilience, high corporate profitability, and the eventual normalization of inflation; at the same time, technology concentration, pressure from AI capital expenditure on free cash flow and shareholder returns, low risk premia, and rapid increases in bond yields are the main constraints. Portfolios should improve return distributions through non-U.S. equities, low-volatility, high-dividend, and value styles, real assets, long-dated call options, CTAs, and equity long-short strategies.

Analysis framework

The research combines Goldman Sachs growth, inflation, and policy cycle indicators with cross-asset market pricing, and uses risk appetite indicators, principal component analysis, dynamic asset allocation models, multivariable logistic regression, random forests, and Shapley value decomposition to assess market conditions and tail risks. The long-term section uses historical samples since 1871, 1900, or 1950 to compare 60/40 portfolios, equity-bond correlations, structural innovation and inflation cycles, asset valuations, and optimal allocations; it also incorporates market pricing, investor positioning, and earnings forecasts as of early August 2026.

Methodology notes

• Macro state identificationGrowth-inflation-policy business cycle framework

  Identifies states such as “Goldilocks,” “reflation,” “balanced bear market,” and stagflation through expanded z-scores of growth, inflation, and policy variables.

  This framework is used to judge whether cross-asset pricing is dominated by growth shocks or interest-rate shocks and to explain changes in equity-bond correlations.

• Market sentiment and positioningGoldman Sachs Risk Appetite Indicator

  Measures cross-asset risk appetite by integrating equity positioning, fund flows, options activity, volatility, and safe-asset positioning.

  The indicator rose above 1.2 in early June 2026, showing that risk appetite remains elevated, although broader sentiment and positioning indicators have returned to more neutral levels.

• Cross-asset factor analysisPrincipal component analysis

  Decomposes common changes in risk appetite into a global growth factor and a monetary policy factor.

  Growth optimism pricing leads macro surprises, while rising long-term real yields usually weigh on risk appetite, driving rotation across asset classes and internal styles.

• Dynamic asset allocationRandom forest 60/40 drawdown model

  Estimates the conditional probability of a drawdown in a 60/40 portfolio based on macro cycle scores.

  The model shows that rising inflation had pushed up portfolio drawdown risk, but this risk has eased as the probability of stagflation shocks has declined.

• Equity tail riskMultivariable logistic regression and Shapley value decomposition

  Estimates the probability that the S&P 500 will experience a drawdown of more than 20% or a gain of more than 35% over the next 12 months, and decomposes the contribution of various variables.

  The asymmetry of the current return distribution has improved from earlier levels, but valuation and business-cycle signals conflict with each other, so tail protection is still needed.

• Long-term portfolio constructionStructural cycle and efficient frontier framework

  Builds long-term return scenarios and optimal asset portfolios based on innovation, inflation, productivity, valuations, and asset correlations.

  Different structural states correspond to significantly different 10-year returns; equities remain relatively expensive, while bond yields are now close to long-term averages, and long-term allocation requires broader asset diversification.

• Carry opportunity assessmentGoldman Sachs Carry Opportunity Indicator

  Integrates risk premia across emerging markets, sovereign and corporate credit, foreign exchange, equity volatility, and yield curves.

  The indicator is close to its lowest level since the global financial crisis, indicating insufficient compensation for current carry trades and vulnerability to growth or interest-rate shocks.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Global equities

  Overweight over 12 months, neutral over 3 months

  Strengths

  Global earnings estimate revisions are strong, the innovation cycle and corporate profitability continue to support returns, and the opportunity cost of underweighting equities too early late in the cycle is high.

  Weaknesses

  Valuations are elevated, risk premia are low, and technology weights and large-cap concentration are at historical highs.

  Comparison

  Preferred over credit on a 12-month basis; regionally, preference is for MSCI Asia Pacific ex-Japan, TOPIX, and S&P 500, with a reduced stance on STOXX Europe 600.

  Risks

  Sticky inflation, rising long-term real yields, downward earnings revisions, deleveraging of technology momentum, and AI investment returns falling short of expectations.

• U.S. equities and technology sector

  Overall still supported, but indiscriminate chasing of technology momentum is not recommended

  Strengths

  High corporate profitability and technology-sector earnings growth support higher valuations, and the current rally relies more on earnings than during the technology bubble.

  Weaknesses

  The Shiller P/E ratio is close to technology-bubble levels, index concentration is rising, and hyperscale cloud provider capital expenditure is weighing on free cash flow.

  Comparison

  In technology-led drawdowns, low-volatility, high-dividend, and value stocks usually outperform the technology sector and the broader market.

  Risks

  Insufficient realization of productivity improvements, declining returns on capital expenditure, pressure on ROE, and a market shift from growth optimism to interest-rate shocks.

• Government bonds

  Neutral over both 3 months and 12 months

  Strengths

  Bond yields are close to long-term averages, valuation setbacks are smaller than for equities, and inflation normalization can bring rate relief.

  Weaknesses

  Rapid yield increases driven by inflation or fiscal concerns can cause price losses, and the equity-bond correlation may turn positive.

  Comparison

  Within duration, preference is for the United States and the United Kingdom, with a reduced stance on Japan; Germany shifts from a short-term preference to neutral over 12 months.

  Risks

  A rapid rise in the U.S. 10-year yield or a move above 5%, repricing of term premia, and central bank policy being more hawkish than market expectations.

• Credit

  Neutral over 3 months, underweight over 12 months

  Strengths

  Higher risk-free rates keep all-in yields attractive, with USD IG and USD HY relatively preferred.

  Weaknesses

  Credit spreads and term premia are low, providing insufficient compensation for growth and interest-rate shocks.

  Comparison

  Preference is for U.S. dollar investment-grade and high-yield credit, with a reduced stance on euro investment-grade and high-yield credit.

  Risks

  Slower economic growth, financing costs remaining high, rising default risk, and sudden spread widening.

• Commodities and real assets

  Overall neutral, but with portfolio hedging value

  Strengths

  Historically, they have performed relatively resiliently during technology-led equity drawdowns and higher-inflation environments, while energy, gold, and broad commodities can provide inflation-sensitive exposure.

  Weaknesses

  Long-term cash-flow characteristics are limited, and prices are highly affected by global growth, the U.S. dollar, and supply shocks.

  Comparison

  In the technology drawdown sample, the average performance of gold and the S&P GSCI was better than equities and traditional 60/40 assets.

  Risks

  Weakening global demand, U.S. dollar appreciation, rapid inflation decline, and a reversal in the supply environment.

• Cash

  Neutral over both 3 months and 12 months

  Strengths

  Provides liquidity and reduces portfolio volatility, facilitating reallocation during market corrections.

  Weaknesses

  If risk assets continue to rise, cash will generate a significant opportunity cost.

  Comparison

  Return stability is higher than equities and credit, but long-term return potential is lower.

  Risks

  Rate cuts leading to lower cash returns, and long-term holdings causing a loss of real purchasing power.

• CTAs, equity long-short, and options strategies

  Used to improve portfolio tail profile and diversify risk

  Strengths

  CTAs have historically performed strongly in higher-inflation environments, equity long-short can benefit from stock dispersion, and long-dated call options can preserve upside convexity.

  Weaknesses

  Strategy returns depend on trends, stock-picking ability, volatility pricing, and execution costs, and options may lose the entire premium.

  Comparison

  Compared with directly reducing equity exposure, these strategies can improve tail risk while retaining some upside participation.

  Risks

  Trend reversals, crowded trades, declines in implied volatility, model failure, and erosion from option costs.

Key data

• Global real GDP growth forecast2.5% in 2026, 2.8% in 2027Goldman Sachs forecast; 2025 was 2.8%.
• U.S. real GDP growth forecast2.1% in 2026, 2.3% in 2027Goldman Sachs forecast.
• Global headline inflation forecast3.7% in 2026, 3.2% in 2027Year-on-year basis; inflation is expected to gradually normalize.
• U.S. CPI forecast3.2% in 2026, 2.3% in 2027Headline inflation is expected to remain elevated before year-end and then normalize.
• Risk appetite indicatorAbove 1.2 in early June 2026The Goldman Sachs Risk Appetite Indicator remains at an elevated level.
• Momentum factor relative volatility3.5xOne-month realized volatility of the momentum factor relative to S&P 500 realized volatility.
• Global asset portfolio coverage sizeUS$289 trillionUsed to calculate the relative weights of different asset classes in the global portfolio.
• Historical drawdowns in the technology, media, and telecom sectorAverage -26.7%, median -15.8%Drawdowns in the technology, media, and telecom sector in the sample; the average S&P 500 drawdown over the same periods was -15.5%.
• Real-asset performance during technology drawdownsAverage +2.0%Gold averaged +9.8% and the S&P GSCI averaged +23.7% over the same periods, indicating that real assets have some diversification value.

Impact & implications

The investment implication is to maintain exposure to risk assets while reducing reliance on single technology momentum. Equities are more attractive than bonds and credit over 12 months, but allocation should prioritize markets with stronger earnings support and diversify concentration through non-U.S. regions, value, high-dividend, and low-volatility styles. Bond valuations are closer to long-term averages than equities and can serve some long-term allocation functions, but they may not necessarily hedge equities when inflation is sticky or yields rise rapidly. Low credit spreads and term premia limit the margin of safety for credit and carry trades. Real assets, CTAs, equity long-short, and longer-dated equity call options can address inflation, trends, stock dispersion, and the risk of missing upside, respectively.

Risks

• Further escalation of the war in the Middle East, causing weaker growth and higher inflation simultaneously.
• Inflation in the United States and other major markets remains persistently above expectations, forcing central banks to maintain tighter monetary policy.
• Long-term bond yields rise rapidly due to sticky inflation or fiscal concerns, triggering simultaneous declines in equities and bonds.
• Technology-sector valuations, weights, and market concentration are too high, leading to momentum-trade deleveraging or drawdowns in large technology stocks.
• Artificial intelligence capital expenditure fails to translate into sufficient productivity, free cash flow, and shareholder returns.
• Global earnings expectations shift from upward revisions to downward revisions, weakening the fundamental support for highly valued equities.
• Credit spreads and risk premia are too low, leaving carry and credit strategies with insufficient buffers against growth or interest-rate shocks.
• The traditional 60/40 portfolio loses the negative-correlation protection between equities and bonds under inflation shocks.
• Options and derivatives strategies may lose the entire premium due to incorrect directional views, volatility changes, or expiration conditions, and selling naked options may also generate significant losses.
• Foreign exchange volatility may significantly alter local-currency returns from cross-regional allocations.

What to watch

• Whether U.S. and global headline inflation normalize after late 2026 as expected.
• The level and pace of increase in the U.S. 10-year Treasury yield, and whether it approaches or breaks above 5%.
• Whether the equity-bond correlation remains positive, and whether market shocks are dominated by growth factors or interest-rate factors.
• Whether the Goldman Sachs Risk Appetite Indicator and positioning in equities, CTAs, options, and fund flows move back toward extremes.
• Whether MSCI AC World earnings estimate revisions can remain positive, and whether U.S. technology-sector earnings growth slows.
• Changes in capital expenditure, free cash flow, and ROE at AMZN, META, MSFT, GOOGL, and ORCL.
• The performance of technology momentum relative to low-volatility stocks, realized volatility, and signs of deleveraging.
• The weight of the top ten stocks and market concentration in U.S. and emerging market indices.
• Whether credit spreads, term premia, and the Goldman Sachs Carry Opportunity Indicator rebound from low levels.
• Whether non-U.S. equities, value, high-dividend, low-volatility, real assets, and CTAs can continue to provide diversification during technology drawdowns.
• The pricing attractiveness of selective put-spread collar strategies and long-dated equity call options.