Market Brief: Level Setting on the Forces Shaping Markets
Dissecting Market Forces
This year's market movements have to date reflected a gap between expectations and reality. Optimism for pro-growth policies to boost the already above-trend US economy has been dampened by two main factors. First, the Trump administration's policy sequencing, where market-unfriendly actions (tariffs, DOGE-driven job cuts, immigration controls) have preceded market-friendly measures (tax cuts, regulatory relief). Second, the accumulation of soft US economic data, which has reset US growth from above-trend to around trend. Meanwhile, prospects outside the US have improved due to several factors: the emergence of cost-effective, globally competitive Chinese AI models, optimism over a ceasefire in Ukraine, and a regime shift in Europe, with increased fiscal spending from Germany and broader defense spending among European countries. Consequently, US risk assets—including equities and credit—have underperformed European and EM counterparts, and the US dollar’s ascent has been checked.
Addressing Tariff Risks
US tariffs have been announced, postponed, introduced, and then exempted for certain goods. The tariffs in effect have raised the US effective tariff rate by about 3%.1 Tariffs on autos, critical imports, and reciprocal tariffs2 could raise the effective rate to about 10%, which is five times the increase seen in the first Trump administration. Tariffs have been implemented faster, at higher rates, and with a broader scope than expected. The economic costs are qualitatively understood as stagflation in the US, characterized by higher near-term inflation and weaker growth, and a growth hit outside the US, reflecting the direct impacts of higher consumer prices and reduced business investment amid elevated trade policy trade policy uncertainty. However, the quantitative impact remains highly uncertain, as it depends on the duration of tariffs and carveouts. The Federal Reserve could resume rate cuts this year if tariffs ease and inflation normalizes, or to guard against downside growth risks, but the bar to cut will be higher than in 2019 unless survey-based inflation expectations ease.
Decoding the US Soft Patch
Weaker US data is hard to ignore—consumer spending has pulled back, the housing market is subdued, sentiment is downbeat, and planned job cuts are rising. Some of this weakness can be explained by weather distortions and issues with statistical adjustments. Negative headlines can also have an outsized impact on consumer sentiment, but this hasn’t always matched spending habits, and federal worker layoffs associated with DOGE-driven efficiency pursuits remain small relative to the US job market. We think the underlying picture painted by hard economic data remains consistent with continued economic expansion; jobless claims are contained, the average pace of job growth over the past three months is decent, disinflation is supporting real wage growth, and private sector balance sheets remain in good shape—a message confirmed by the latest corporate earnings season. Goldman Sachs Global Investment Research has recently raised the probability of a US recession in the next 12 months from 15% to 20%, with policy choices cited as the key driver—specifically tariffs—rather than macroeconomic fundamentals. This probability could decrease if policies are adjusted in response to sustained weakness in the data.
Sizing the German Fiscal Transformation
Germany's historical shift towards increased defense and infrastructure spending, along with more fiscal room at the state level, is a potential positive catalyst for medium-term growth in Germany and the Euro area.3 However, the near-term outlook is clouded by the risk of US tariffs. The subdued starting point for growth and disinflation suggests the ECB will proceed with a couple more rate cuts to neutral. Fiscal constraints in high-debt, high-deficit economies like France and Italy, along with financing and personnel, infrastructure, equipment, and R&D considerations, indicate that the transition to security and defense independence in Europe will be a multi-year initiative.
AI Question Marks
The Magnificent 7, a group of seven large-cap US technology companies known for their leadership in generative AI investments, have significantly boosted US equity returns in recent years. However, this year has been markedly different. The S&P 500 total return index is down 5% year-to-date, and the Magnificent 7 are down 15.2%. In contrast, at the same point in 2024, the S&P 500 index was up 7.6%, and the Magnificent 7 were up 12.9%.4 Investors are questioning whether today's AI leaders will benefit from their investments tomorrow, especially with the emergence of cost-effective Chinese AI models. We think this questioning is valid; none of the top ten US companies by market cap in 1990 are in the top ten today, and only Apple and Microsoft remain from the 2010s. The same migration of winners and losers should be expected with the AI theme as focus shifts from AI investment to AI adoption.5 The winners will also potentially be more regionally diverse. Indeed, the Hang Seng TECH Index has gained more than 30% year-to-date.6
Implications for Equities—From Magnificent 7 to Magnificent Diversification
Developments so far this year reinforce our conviction that investors should broaden their equity horizons beyond US large-cap stocks to include more regions, sectors, and styles. After US equities consistently outperformed the rest of the world for the better part of the past 15 years, diversification is once again proving to be an effective strategy to maximize financial returns.7 For example, European and German equities have delivered a total return of over 12% in US dollar terms year-to-date.8 Sector dispersion also creates opportunities for active management to discern between value and value traps. For instance, European banks have outperformed the Magnificent 7 since 2022, while European autos face structural headwinds from the energy transition and competition from China. Europe’s new growth and security path offers long-term investment potential across various sectors for bottom-up stock pickers in areas such as specialty chemicals, medical equipment, luxury goods, utilities, and defense. Additionally, the US policy agenda reinforces prospects for re-industrialization, creating unique structural opportunities related to supply chain, resource, and national security. Furthermore, AI opportunities are extending beyond early-stage companies like semiconductors to those benefiting from AI adoption, such as software companies. Currently, only 6.1% of US firms use AI to produce goods or services.9 Eventually, AI investment opportunities will span various industries, boosting productivity. Lastly, US small-cap stocks offer a way to diversify away from large-cap stocks while being somewhat insulated from trade wars—fundamental and quantitative approaches can help identify and exploit inefficiencies in this smaller, less researched universe.
Implications for Fixed Income— Steady Income Potential in Unstable Times
The benefits of bonds have been evident so far in 2025, with US Treasury yields declining amid growth concerns. This decline has helped offset risk-off moves in other asset classes. We continue to see value in positioning for higher Japanese bond yields amid a virtuous cycle of wage growth and inflation, along with steeper yield curves, including in Europe where near-term ECB policy and medium-term fiscal prospects reinforce conviction in this view. Additionally, we believe total return investors in corporate bonds are relatively insulated from the risk-off tone, as most income from corporate bonds today comes from high interest rates rather than credit spreads.10 In our view this dynamic may help mitigate downside risks from equity market volatility or economic growth deterioration. More broadly, credit markets have generally remained stable, with spread widening being relatively orderly. With credit fundamentals in good shape, we continue to see value in seeking steady streams of income from US corporate credit and securitized sectors. Recent market volatility has slightly loosened valuation constraints, allowing us to add to high conviction views at more attractive valuations in our clients fixed income portfolios. We have turned more cautious on the US dollar, whose appreciation trend has stalled despite tariff risks due to lower US rates and growth concerns. However, currency options continue to offer investment potential to capitalize on elevated currency market volatility.
What We’re Watching
Trade tensions have the potential to generate further market volatility. We are also mindful of the inflationary effects that these policies, along with others such as immigration controls, might introduce, even if they are later adjusted. We are closely monitoring the imposition of additional tariffs and the anticipated announcements on the long-term US tariff strategy in early April, when findings from the America First Trade Policy memorandum published in January are expected to be released. However, there are also potential positive catalysts on the horizon. The Trump policy agenda could shift towards market-friendly policies such as tax cuts and regulatory relief, though this would reintroduce a risk for credit investors—the prospect of a rise in debt-funded M&A. A ceasefire in Ukraine could unlock further upside in the European macro and market outlook. Additionally, central banks may deliver insurance rate cuts to guard against downside growth risks from tariffs. Overall, we believe it is essential for investors to stay focused on fundamentals, maintain diversification, be dynamic, and exercise discipline to successfully navigate the rapidly changing investment landscape.
1 As of March 12, 2025, this includes a tariff of 25% on steel and aluminum, a 20% increase on imports from China, and 10-25% on a small share from Canada and Mexico that do not comply with the US-Mexico-Canada Agreement (USMCA). Source: US Economics Analyst Updating Our Economic Forecasts to Include Larger Tariff Increases. The US effective tariff rate is a measure that calculates tariff revenues as a percentage of all imports.
2 The reciprocal tariff is crucial to monitor, not because other countries impose higher tariffs on the US, but because the administration views Europe's 20% VAT as equivalent to a tariff. Source: Goldman Sachs Global Investment Research Global Views: From Above to Below March 10, 2025.
3 Goldman Sachs Asset Management. Fixed Income Musings. As of March 7, 2025.
4 Macrobond, Goldman Sachs Asset Management. As of March 11, 2025.
5 Goldman Sachs Asset Management. Fixed Income Musings. As of January 31, 2025.
6 Bloomberg. As of March 11, 2025. Based on Hang Seng TECH Index.
7 Goldman Sachs Global Investment Research, Global Strategy Views. As February 25, 2025.
8 Bloomberg, Goldman Sachs Asset Management. As of March 11, 2025. Based on the MSCI Europe Index and the DAX Total Return Daily Hedged USD index.
9 Goldman Sachs Global Investment Research. AI Adoption Tracker. As of December 12, 2024.
10 Goldman Sachs Asset Management. As of March 7, 2025.
