The "Goldilocks" of the US stock market faces three major risks! Goldman Sachs warns of stagflation, long bond turmoil, and a significant decline of the dollar

According to the Zhitong Finance APP, after the initial impact of Trump's tariff policy, the U.S. stock market benchmark index—the S&P 500—has experienced one of the fastest index recovery processes in history. Meanwhile, driven by the unprecedented AI boom, heavyweight tech giants like Nvidia, Microsoft, and Google have seen strong gains, leading the Nasdaq 100 index, known as the "global technology stock barometer," to also reach new highs with a more vigorous upward trend than the S&P 500. However, a recent report from Goldman Sachs points out that the so-called "Goldilocks" (an economy that is neither too hot nor too cold, maintaining moderate growth and stable low inflation) optimistic rising environment faces three key risk factors.

As of Wednesday's market close, the S&P 500 index rose to 6263 points, up 29% from its April low, hovering near its historical peak—just a step away from the all-time high of 6284 points. The global stock market benchmark index—the MSCI Global Index—also recently reached a historical high, mainly due to the global AI boom driving tech stocks up, as well as easing geopolitical tensions and increasing market expectations for the Federal Reserve to cut interest rates within the year.

The "Goldilocks" market refers to a balanced state where the economy and policies are "just right." When growth is moderate, inflation is mild, and liquidity is ample, it provides a breeding ground for multi-asset gains. However, this environment is fragile and changeable. The three risks listed by Wall Street financial giant Goldman Sachs—U.S. economic stagflation or downturn, rising long-term bond yields, and disorderly declines in the dollar—if any one of them materializes, could disrupt this "just right" tranquil market environment.

To defend against the aforementioned three risks, Goldman Sachs advises investors to actively allocate to gold and certain emerging markets: to hedge against dollar depreciation and stagflation risks; and recommends positioning in short-duration bonds: to mitigate capital losses from rising long-term yields; finally, Goldman Sachs also recommends low-volatility defensive stocks and financial stocks: to provide relative downside protection when volatility increases or long-term yields rise, causing the yield curve to steepen.

The strategy team led by Goldman Sachs portfolio strategist Christian Müller-Griesmann has identified stagflation or negative growth surprises, turmoil in the long end of the yield curve bond market, and a cliff-like disorderly decline in the dollar as the three main risks that could undermine the current "Goldilocks" macroeconomic scenario that investors are betting on.

From mid-April to the end of the first half of the year, risk assets like stocks experienced a V-shaped rebound, with market sentiment undergoing significant fluctuations. Goldman Sachs' proprietary risk appetite indicator shows that this reallocation process was rapid and intense.

Some safe-haven asset holdings indicate "risk aversion" (i.e., risk-off), but the funds flowing into stocks and bonds remain very "risk-on" (also known as chasing risk). Although the S&P 500 index has reached an all-time high, under the "Goldilocks" optimistic macro environment, the risk-on momentum in the U.S. stock market can be said to be only increasing.

Currently, both risk appetite and market positions are above long-term averages, which weakens some upward momentum and indicates a certain degree of complacency in the market. Therefore, the Goldman Sachs strategist team led by David Kostin warns that the stock market presents negative asymmetry in the short term, with a higher probability of a significant pullback than continued gains. Global geopolitical risks remain, and valuations no longer have supportive attributes.

The Goldman Sachs economist team points out that leading indicators and business cycle scores suggest that the U.S. economy faces risks of slowing growth or even "stagflation," warranting a more cautious attitude towards the stock market. For fixed-income investors, the rise in term premium risk has been a typical feature of the bond market in 2025. Goldman Sachs is concerned about the fiscal policy expansion following the passage of the Trump administration's "big and beautiful" plan and the continuously growing bond supply. Compared to previous market pricing, the likelihood of yield shocks in long-term bonds driven by term premium is higher, but the U.S. Treasury yield curve may steepen as the Federal Reserve faces pressure for easing policies, leading to a decline in short-term U.S. Treasury yields.

The so-called term premium refers to the extra yield that investors require for holding long-term bonds due to the associated risks. Some economists believe that during the Trump 2.0 era, national debt and budget deficits will be much higher than official forecasts, mainly because the new government led by Trump focuses on an economic growth and protectionism framework of "domestic tax cuts + external tariffs," combined with an increasingly large budget deficit, U.S. Treasury interest, and military defense spending. The U.S. Treasury's bond issuance may be forced to expand even more in the "Trump 2.0 era" than the Biden administration's excessive spending, coupled with the potential significant reduction of U.S. Treasuries by China and Japan under "de-globalization," making the "term premium" likely to be higher than in previous data.

Goldman Sachs also emphasizes that a weaker dollar poses a threat to U.S. risk assets. A weak dollar undermines the "American exceptionalism" that has long driven the rise of U.S. assets, further exacerbating stagflation risks in the context of tariffs and making bond investors more concerned about the independence of the Federal Reserve and fiscal policy risks. Capital outflows from the U.S. and headwinds from foreign exchange hedging demand may also prolong the dollar's decline. The heavy positions of international investors in U.S. stocks and dollars, combined with exchange rate fluctuations, have significantly increased portfolio risks.

Although Goldman Sachs holds a tactically neutral stance on stocks, credit assets, and bonds, it recommends diversification to hedge against the aforementioned three major risks. The Goldman Sachs team recommends gold, selected emerging markets, short-duration bonds, low-volatility defensive stocks, and financial stocks as means to withstand the risks of drastic changes in the "Goldilocks" environment