Goldman Sachs: U.S. stocks face a nearly 20% decline possibility, recession is a significant risk, and the only substantial buyers currently are retail investors

Goldman Sachs' latest warning states that the U.S. stock market faces a nearly 20% decline risk, with economic recession posing a significant threat to the market.

Since the intraday low on April 7, the S&P 500 index has risen about 18%. If it continues to rise in the coming days, the market is expected to re-enter a technical bull market range. The significant rebound in U.S. stocks is attributed to traders believing that the reaction to the potential damage from Trump's trade war a month ago was overly severe. Trump's 90-day suspension of the reciprocal tariff plan has significantly eased market concerns.

However, Goldman Sachs economists remain cautious:

• Goldman Sachs' chief political economist Alec Phillips warns that Trump's comments regarding the U.S.-UK trade agreement indicate that many countries will ultimately face higher tariffs than before Trump's second term.
• In a podcast released on Thursday titled "On the Edge of Another Decline?", Goldman Sachs' chief economist Jan Hatzius and chief global equity strategist Peter Oppenheimer also expressed notable caution.
• Goldman Sachs macro trader Bobby Molavi pointed out that the only substantial buyers during this downturn are retail investors.

Why is Goldman Sachs cautious?

Hatzius reiterated that he expects a 45% chance of a U.S. economic recession in the next 12 months. He emphasized, "The risk of recession is very significant."

Hatzius acknowledged that recent data has been mixed, with soft data such as sentiment surveys showing weakness, while hard data like the latest non-farm payrolls performing relatively well. He explained that this discrepancy is understandable, as historically, hard data typically has a lag of about 60 days. This time, the lag may be longer because many trade activities were conducted in advance to avoid tariffs.

Hatzius also pointed out that if the Federal Reserve passively waits to see whether inflation is a temporary shock or a persistent pressure, and only takes action when the labor market begins to deteriorate, once a recession occurs, it may force the Fed to cut rates by as much as 200 basis points from current levels.

Oppenheimer stated that the recent strong rebound in the U.S. stock market is mainly due to investors feeling relieved by Trump's suspension of tariffs, decent corporate earnings reports, and active bottom-fishing by retail investors. However, he cautioned that the first-quarter earnings reports released so far do not yet reflect the period following the tariff turmoil:

If hard data begins to deteriorate, especially in the U.S. labor market, I believe the market will pay more attention to the possibility of recession, and the stock market may decline from current levels, which is also our core judgment.

It is important to remember that the price-to-earnings ratio of the U.S. stock market has rebounded to 20 times. This is not cheap. If earnings decline by 10% during a typical recession, and valuation levels are also adjusted downwards, the S&P 500 index could fall to 4,600 points.

Oppenheimer also noted that as the advantages of large U.S. technology companies diminish, foreign investors are reducing their exposure to U.S. stocks, which will put greater pressure on the U.S. stock market. Currently, the U.S. accounts for 70% of global stock market valuations, and this proportion is expected to decline.

Oppenheimer emphasized that in the short term, the U.S. stock market still faces an "asymmetric downside risk" situation Despite some pessimism about the market's next moves, Oppenheimer believes that we are not currently in a "structural bear market," which is a prolonged deep decline caused by asset bubbles and imbalances in the private sector, such as in Japan in the late 1980s or during the global financial crisis of 2007-2008. Such bear markets typically decline by around 60% and last longer.

The Only Substantial Buyers Are Retail Investors

Goldman Sachs macro trader Bobby Molavi stated that, to some extent, the world has changed. But from another perspective, we have returned to square one. If January and February were periods filled with hope, expectation, and arrogance, then March and April were filled with despair, disappointment, and anxiety. After experiencing a series of policy reversals, news bombardments, and severe market fluctuations, the stock market has almost returned to its position at the beginning of the year.

The main beneficiaries of this sell-off and rebound are the only true "buy-the-dip" investors we have seen—retail investors. Retail and corporate buybacks average around $1 trillion annually, providing support for U.S. stocks in the context of scarce new stock issuances.

In terms of capital flows, the narrative of "selling" in the U.S. has been exaggerated. There is indeed net selling, and it is a sell-off across asset classes including stocks, bonds, and currencies. However, it is important to note that despite the damage to the U.S. reputation, it remains an extremely attractive capital haven. Some investors have shifted their allocations to Europe, India, Japan, etc., but after a surge in such repositioning trades in April, May has returned to a pace for 2024, with daily trading volumes significantly declining and the market normalizing.

The U.S. household savings rate has decreased, but stock holdings have increased, and cash reserves are being depleted, with some flowing into the market. Regarding employment, Molavi mentioned that he senses anxiety and uncertainty among executives, which could trigger precautionary layoffs, and with expectations of AI enhancing efficiency, the demand for labor may decrease.

Molavi pointed out that if the unemployment rate rises from 4% to 7%-8%, and household/retirement account stock holdings turn to selling, we need to be cautious as the tailwinds for the stock market could turn into headwinds