Rising energy and fading momentum compress cross-asset diversification; neutral short term, modestly pro-risk over 12 months

Overview

This report is Goldman Sachs GOAL's weekly cross-asset research, focusing on how further increases in energy prices and the unwinding of equity momentum affect global asset performance, correlations, risk appetite, and portfolio allocation. The report argues that since July, markets have been driven by two main themes: first, changes in policy and inflation pricing stemming from energy prices; second, the pullback in momentum trades tied to AI capital spending. The effects of these two themes are uneven across assets: equities are mainly driven by momentum, while macro assets are more driven by rates and policy expectations.

Core views

The core view of the report is that short-term macro headwinds and long positioning may weigh on risk-adjusted returns, so it stays tactically neutral over a 3-month horizon; however, it remains modestly pro-risk over a 12-month horizon, mainly relying on earnings growth in the second half of the year to support equities. As correlations rise across assets and regions, traditional diversification opportunities are diminishing; more effective diversification comes from defensive/quality styles and real-asset equities amid high dispersion within equities. For protection against growth shocks, put options on the Russell 2000, US Consumer Discretionary, US Banks, China equity, and the S&P 500 are attractive because their implied volatility remains relatively low compared with some single stocks, the Nasdaq, or EM equity volatility.

Analysis framework

The report evaluates macro shocks, momentum pullbacks, and asset allocation implications through frameworks including cross-asset returns, front-end rates, equity momentum, risk appetite indicators, correlation matrices, valuation and risk premia, fund flows, CFTC positioning, implied/realized volatility, market-implied recession probability, and equity drawdown probability models.

Methodology notes

• cross_asset_regressionmonth-to-date multivariate regression

  Cross-asset driver decomposition

  Using month-to-date multivariate regression, the report compares the impact of momentum and front-end rates on different assets, showing that equities are more influenced by momentum, while macro assets such as bonds, FX, and gold are more correlated with front-end rates.

• risk_appetiteGS Risk Appetite Indicator and PCA

  Risk appetite and principal component analysis

  The report cites risk appetite indicators and principal component analysis to decompose market performance into factors such as global growth, monetary policy, and the US dollar, in order to observe the transmission of macro risks.

• portfolio_construction60/40, risk parity and dynamic allocation strategies

  Balanced portfolio and dynamic allocation assessment

  The report compares 60/40, risk parity, volatility-targeting, and momentum-overlay strategies to assess portfolio resilience in an environment of rising correlations.

• options_hedging3-month 25-delta implied volatility

  Attractiveness of put option hedging

  The report compares 3-month 25-delta implied volatility and believes that put options on some equity indices and sectors are relatively cheap and can be used to hedge growth shocks.

• macro_probability_modelmarket-implied US recession and S&P 500 drawdown probability models

  Market-implied recession and drawdown probability

  The report uses market indicators and multivariate logit models to track US recession probability, the probability of a sharp S&P 500 drawdown, and upside probability, and uses Shapley values to explain the sources of contribution.

Asset mapping & comparison

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

• Equities

  Modestly positive over 12 months, but constrained in the short term by fading momentum and macro headwinds

  Strengths

  Earnings growth may support performance in the second half, and high dispersion within equities provides opportunities for style and sector selection.

  Weaknesses

  Momentum trades related to AI capital spending are pulling back, and short-term long positioning may weigh on risk-adjusted returns.

  Comparison

  Compared with bonds, FX, and gold, equities are less correlated with front-end rates and more sensitive to momentum.

  Risks

  Rising macro risks may lead to greater downside risk for equities.

• Low Vol、Dividend Aristocrats、REITs、Infrastructure

  Viewed by the report as better sources of portfolio diversification

  Strengths

  Since July, defensive/quality styles and real-asset equities have delivered positive returns and can balance portfolios with heavier innovation exposure.

  Weaknesses

  If risk appetite shifts back toward high-momentum growth stocks, defensive styles may lag relatively.

  Comparison

  When traditional cross-asset diversification declines, style diversification within equities becomes more valuable.

  Risks

  Higher rates or macro shocks may still weigh on REIT and Infrastructure valuations.

• Commodities and Energy

  Rising energy prices are an important driver of macro pricing and inflation expectations

  Strengths

  The Energy sector has performed strongly recently, carries a high weight in the S&P GSCI, and contributes significantly to the index.

  Weaknesses

  With prices near yearly highs, it is more sensitive to geopolitics and demand expectations.

  Comparison

  Energy has a stronger influence on policy pricing and inflation expectations than most other commodity sectors.

  Risks

  If Middle East tensions ease or a growth shock weakens demand, energy prices may fall back.

• Government bonds

  In the short term, affected by policy expectations and inflation pricing

  Strengths

  They may still provide defensive characteristics in a growth shock.

  Weaknesses

  Rising energy prices and changes in inflation pricing may push yields higher and weigh on bond returns.

  Comparison

  The report points out that macro assets such as bonds are more correlated with front-end rates.

  Risks

  Hawkish central bank rhetoric or inflation repricing may lead to higher rate volatility.

• Gold

  As a macro asset, it is more correlated with front-end rates

  Strengths

  It can provide some safe-haven function amid macro uncertainty.

  Weaknesses

  The table shows negative returns for precious metals over both 1 week and 1 month recently.

  Comparison

  Unlike equities, gold is closer to a rate-driven asset in the report's framework.

  Risks

  Higher real rates or a stronger US dollar may weigh on gold.

• Credit

  Underweight in the 12-month allocation

  Strengths

  Credit can still provide coupon income.

  Weaknesses

  The report underweights credit in its 12-month asset allocation, implying less attractive relative risk-reward than equities.

  Comparison

  The report monitors credit attractiveness through relative valuation between equities and credit, and the correlation between CDS and equity volatility.

  Risks

  Growth shocks, higher financing costs, or weaker risk appetite may widen credit spreads.

• Equity puts

  Tools for hedging growth shocks

  Strengths

  The report finds put options on the Russell 2000, US Consumer Discretionary, US Banks, China equity, and the S&P 500 attractive because their implied volatility remains relatively low.

  Weaknesses

  If markets continue to rise or volatility declines, option buyers may lose the premium.

  Comparison

  Compared with volatility on single stocks, the Nasdaq, or EM equity, these put options are more attractively priced.

  Risks

  Option strategies involve premium loss risk and risks related to strike and maturity selection.

Key data

• Energy pricesGasoline and natural gas prices are less than 10% below their highs for the yearThe report says renewed escalation in the Middle East has continued to push oil prices higher, with even larger gains in energy product prices.
• Equity momentumS&P 500 Momentum underperformed the market by about 5% again on a weekly basisThe continued unwinding of momentum/AI-related trades is an important driver of equity performance this month.
• Asset allocation viewNeutral over 3 months; modestly pro-risk over 12 monthsThe 12-month allocation is overweight equities, neutral cash, bonds, and commodities, and underweight credit.
• Diversification statusAverage pairwise two-week correlations across regions and assets have risen since the start of the monthThe report believes traditional diversification opportunities are becoming limited.
• Commodity sector performanceS&P GSCI: 6.8% over 1 week, 5.8% over 1 month, 40.4% over 1 year; Energy: 13.8% over 1 week, 13.3% over 1 month, 66.2% over 1 yearThe table shows that Energy has a 54.4% weight in the S&P GSCI and is the main contributor to recent commodity performance.
• Precious metals performancePrecious Metals: -2.7% over 1 week, -9.5% over 1 month, 21.2% over 1 yearAlthough the report classifies gold as a macro asset linked to front-end rates, precious metals in the table have shown weak recent returns.

Impact & implications

For portfolios, higher energy prices and shifting policy expectations may continue to limit the short-term risk-adjusted returns of risk assets; high dispersion within equities means that sector, style, and quality selection matter more than simple cross-asset allocation. The report leans toward using defensive/quality styles and real-asset equities to improve the balance of portfolios with heavier innovation exposure, while also using relatively cheap equity put options to hedge growth shocks.

Risks

• Further increases in energy prices may push up inflation expectations and affect central bank policy pricing.
• Continued unwinding of equity momentum and AI-related trades may weigh on the performance of major equity indices.
• Rising cross-asset and cross-regional correlations will weaken the effectiveness of traditional diversification.
• Long positioning and macro headwinds may reduce short-term risk-adjusted returns.
• Rising macro risks may trigger larger equity downside risk or growth shocks.
• Options and ETF-related strategies carry risks including premium loss, liquidity, discount/premium, and execution risk.

What to watch

• Whether Middle East developments and prices of oil, gasoline, and natural gas continue to approach or break yearly highs.
• Changes in US and European 2-year inflation pricing and central bank rhetoric.
• The relative performance of S&P 500 Momentum and AI capital spending-related stocks.
• Whether pairwise correlations across assets and regions continue to rise.
• The relative performance of defensive/quality and real-asset equities such as Low Vol, Dividend Aristocrats, REITs, and Infrastructure.
• Implied volatility of put options on the Russell 2000, US Consumer Discretionary, US Banks, China equity, and the S&P 500.
• Market-implied US recession probability, S&P 500 drawdown probability, fund flows, and CFTC positioning.