Time to diversify from US stocks?

The odds of a recession are still low. # # --------------------------------------------------------------- The key takeaways today: - Why the US stock market is so much bigger than others - Has a US recession grown more likely? - The US job market is at an inflection point - A ground report from the heart of AI innovation - The UK pound will struggle to regain its pre-Brexit levels - Briefings Brainteaser: Which non-energy sector will receive $200 billion in Saudi Arabian investment? Was this newsletter forwarded to you? [Sign up now](. --------------------------------------------------------------- Why it may be time to diversify from US stocks The size of the US stock market has grown immensely relative to other equity markets since the financial crisis in 2008. “It's a bit unprecedented," [says Peter Oppenheimer]( chief global equity strategist and head of macro research in Europe for Goldman Sachs Research. While the US has had the largest stock market and the biggest economy for a long time, the gap with other markets has widened since 2008. “To some degree, that's because the US had a more successful recovery after the financial crisis than Europe or Asia,” he says. But US market cap has also grown considerably relative to GDP, whereas that ratio is roughly unchanged in much of the rest of the world. On its own, Oppenheimer says, that isn't necessarily a sign of irrational exuberance. US companies have seen much more profit growth than their counterparts in the rest of the world, and that difference helps explain the scale of the market capitalization. In addition, technology companies have had the strongest growth in profits since the financial crisis, and tech is a much larger component of the US market. But that has also resulted in a US market that has substantially higher valuations than markets in other geographies around the globe. “It implies that the advantage in the US will continue in the future, but that isn't necessarily clear,” Oppenheimer says. “This isn't a reason to say the US is likely to structurally underperform, but there may be more reasons to be more diversified geographically as the valuation gaps become more extreme.” --------------------------------------------------------------- The odds of a US recession are still low On the back of a weaker-than-expected July employment report, Goldman Sachs Research raised its 12-month odds of a US recession to 25% from 15%. But David Mericle, chief US economist at Goldman Sachs Research, sees the recession risk as limited because economic data still looks relatively solid and there are no major financial imbalances. “I don't think there's any negative shock at the moment, and it's rare that the economy just rolls over spontaneously,” Mericle says on [Goldman Sachs Exchanges](. The Federal Reserve also has 525 basis points of room to cut rates to support the economy if necessary, he points out. “I suspect what we are seeing is more deceleration than an actual dip into recession, and at some level that was inevitable because 2023 was a pretty exceptional year,” Mericle says. In case you missed it: Goldman Sachs Asset Management [shares its views]( on the market volatility and maintains the investment conclusions [outlined in its mid-year outlook](. --------------------------------------------------------------- The US job market is at a turning point Job openings have been steadily declining in the US as the labor market cools. While labor demand remains healthy and should continue to provide a buffer against joblessness, there are signs that could be changing, according to Goldman Sachs Research. For economists, the “[Beveridge Curve]( is a way to visualize the relationship between unemployment and job openings. Since March 2022, the curve has been very steep, meaning job openings fell (from unusually high levels) but there was little increase in unemployment. Now the market has returned to the flatter part of the curve, meaning a decline in job openings will likely have a greater impact on unemployment. If so, the job market is at an inflection point. Further significant softening in labor demand would hit actual jobs, not just open positions, and could push up the unemployment rate more significantly beyond the increase seen in the July employment report. --------------------------------------------------------------- Will the $1 trillion of generative AI investment pay off? A wave of investment worth nearly $1 trillion is expected to pour into generative artificial intelligence in the coming years. [Will it be worth it]( To see where the industry is headed, Brook Dane and Sung Cho, portfolio managers on the Fundamental Equity team in Goldman Sachs Asset Management, met with executives from 20 leading technology companies driving AI innovation. There are risks. Only a small handful of companies can compete in the development of general-purpose large language models. It may turn out to be a winner-takes-all market, with sharp losses for the companies that fall behind, even after immense investment. Applications that warrant the sheer amount of spending are yet to fully emerge. For now, the AI competition is largely concentrated among a few, large public companies with deep resources. However, the team sees signs that industry- and vertical-specific models may emerge, which would result in a wider breadth of winners from the AI arms race. Conversations with the largest tech companies indicate that some executives are already seeing a return on their AI hardware investments. And a new generation of chipmakers' products are beginning to hit the marketplace, which could mean a wider range of beneficiaries in the semiconductor industry from the AI wave. In case you missed it: Read our Top of Mind report "[Gen AI: Too much spend, too little benefit?]( --------------------------------------------------------------- Why the UK pound is unlikely to regain its pre-Brexit levels One of the frequent questions that clients ask Goldman Sachs Research's Kamakshya Trivedi is whether the pound can regain the levels it traded at before Brexit in 2016. While he expects the pound to rally against the US dollar and the euro over the coming year, Trivedi, the head of Global Foreign Exchange, Interest Rates and Emerging Markets Strategy Research, says [the pound is unlikely to reach pre-Brexit levels]( again anytime soon. Goldman Sachs Research's estimate of fair value is around £1.25 versus the dollar, compared with around £1.45 just before Britons voted to leave the EU. “If you are going to have a big disruption in the trading arrangements with one of your largest trading partners, which is what Brexit included, there is going to be an impact on the currency,” he says. That said, Trivedi sees reasons to expect the pound to be strong in the next 12 months. Goldman Sachs Research recently raised its 12-month target for the British pound versus the dollar to £1.32 (from £1.28 previously). The currency rose to £1.30 in July against the greenback, its highest level in a year. (The pound traded at around £1.70 to the US currency in July 2014, two years before the Brexit vote.) - “The pound typically does well in a friendly global macro outlook,” Trivedi says. Traders and investors are beginning to relax about the risks of inflation, and worries of recession have faded. When equity markets are trading firmly, and interest rates are moving in a range or even declining, the British currency tends to perform strongly. - The Bank of England is no longer a dovish outlier when it comes to monetary policy, which has been one of the things keeping the pound lower in recent years. The European Central Bank, the Bank of Canada, and Sweden's Riksbank have cut their policy rates this year and the US Fed is expected to start cutting rates in September. --------------------------------------------------------------- Briefings Brainteaser: Big spending plans Saudi Arabia's capital expenditure is expected to touch $1 trillion by the end of the decade, and close to half of that investment is reserved for energy projects, according to Goldman Sachs Research. Which non-energy sector will receive the biggest share of the remaining investment, estimated at $200 billion? A) Transportation and logistics B) Metals and mining C) Digitalization D) Semiconductors [Check the answer here](. --------------------------------------------------------------- Goldman Sachs in the news By clicking on these links, you will be redirected to external websites that Goldman Sachs does not own or operate. Goldman Sachs is not responsible for the products, services, or content provided on those sites. Please refer to each external website's terms, privacy and security policies for details. [CNBC]( Jul 31 Goldman Sachs' client investment strategist on key investment themes to watch (3:43) [Bloomberg]( Aug 6 Goldman Sachs CEO David Solomon says the Fed will forgo emergency cut despite weak jobs data (3:31) --------------------------------------------------------------- --------------------------------------------------------------- Some of the images used in this newsletter are sourced via Getty Images. 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