Goldman Sachs partner Mark Wilson recently pointed out that global equity markets are facing increasingly clear upside opportunities before the end of the year. The market has already fully priced in stagflation risk, and as a more benign "Goldilocks" economic scenario gradually emerges, investors need not wait for the US midterm elections to conclude before returning to the market and participating in risk asset investment.

Recent price action in the market is confirming this optimistic expectation, with AI-driven "fear of missing out" (FOMO) having returned to the market. Following Meta's launch of the Muse product, expectations for the timeline of large-scale AI adoption by consumers have accelerated significantly, driving AI-themed assets such as the Nasdaq index to achieve a strong upward breakout on Monday, after three months of consolidation and position reduction following a historic second-quarter surge.

At the same time, US bond yields have risen again. Unlike previous episodes driven by competition for funds from government and AI capital expenditure, or inflationary pressure from energy prices, this round of yield increases is mainly supported by stronger-than-expected data such as the Purchasing Managers' Index (PMI), reflecting continued strong US nominal economic growth, and the stock market has managed to hold its gains despite significant yield volatility.

Currently, the market is broadly concerned that the seven-month consecutive rise in US ten-year Treasury yields — the longest streak in fifty years — will eventually drag down the stock market, and investors tend to prefer waiting until Gulf tensions ease and the midterm elections pass safely before adding risk exposure. However, Goldman Sachs' analysis breaks this consensus, pointing out that substantive improvements in the three major fundamentals of inflation, economic growth, and corporate earnings are providing a solid foundation for a year-end stock market rally.

Easing Inflation Pressure and the Deflationary Effect of AI

For some time, due to the impact of the Iran conflict, rising energy prices masked the downward trend in core inflation.

But Goldman Sachs points out that tariff pass-through effects are currently weakening, and rate hikes along with the consequent tightening of financial conditions have taken effect. If logistics flows through the Strait of Hormuz return to normal, energy prices will face significant downside risk, especially considering that Iran's maximum bargaining chip window is expected to close around November 2, and a new deflationary energy narrative could emerge at any time.

More importantly, Meta's Muse product has fired the "first shot" of deflation in the consumer goods and services sector.

Goldman Sachs' research on the "era of commercial agent-based AI" shows that technological progress is substantially reducing costs on the consumer side, which will become a more important deflationary driver than falling energy prices.

Cooling Economic Growth Expectations Limit Central Bank Hawkishness

Despite geopolitical and energy price uncertainties over the past six months, US economic activity has continued to show greater resilience than expected. However, research by Goldman Sachs economist Jan Hatzius shows that this upside risk is diminishing, and the second derivative of economic growth will begin to slow.

As fiscal benefits such as tax cuts fade, rising gasoline prices and mortgage rates will impact certain sectors of the economy and consumers.

In addition, while the capital expenditure cycle in the AI sector will continue, its growth rate will also slow. Combined with expectations of declining inflation, central banks' future rate hikes are highly likely to be smaller than current market pricing.

Mark Wilson emphasized that now is not the time to worry about rising yields — such concerns were only reasonable seven months ago.

Core Earnings Remain Strong, Fundamentals Support Stock Market Valuations

In response to the current intense debate about the sustainability of corporate earnings and "earnings bubbles," Ben Snider, head of Goldman Sachs' US strategy team, believes that some companies currently exhibit "excess earnings," but overall no earnings bubble has formed.

Goldman Sachs advises investors to note three facts:

First, investors should not pay a high premium for record-breaking "other income"; second, memory chips and certain semiconductor stocks are indeed in an excess earnings state; third, at least until the end of 2027, core corporate earnings are highly likely to remain particularly strong even if growth slows, providing fundamental support for stock market valuations.

Stagflation Narrative Collapses, "Goldilocks" Reshapes Market Landscape

The market had previously been trying to price in a significant slowdown in economic growth and earnings as well as higher interest rates, but macroeconomic data does not support this perfect "stagflation" narrative. On the contrary, slowing growth, diminishing inflation threats, softening central bank stances, and a year of valuation de-rating together constitute a favorable market combination.

Goldman Sachs believes the current situation is remarkably similar to the bull-bear debate during the major technological transformation period of the mid-to-late 1990s.

If the market ultimately ushers in a "Goldilocks" scenario — where economic growth is just right, neither too hot to trigger inflation nor too cold to cause recession — then the historical pattern of year-end stock market rallies after midterm elections still applies.

Mark Wilson concluded that investors should not wait for the midterm elections to end before taking action, and that with the energy price threat fading, European and UK stock markets are also well-positioned to participate in this rally.