Goldman Sachs believes the economic cycle remains in its early stages, yet market valuations for certain assets have become excessively high. The firm anticipates artificial intelligence and technology stocks will experience high volatility near peak levels, while capital continues flowing toward "cheaper" cyclical assets. Investors should exercise caution regarding overvalued sectors and embrace emerging markets and old-economy segments that benefit from economic recovery, utilizing diversified allocations to navigate future market fluctuations and divergences.

According to tracking data, Goldman Sachs released a report on February 19 titled "Global Market Outlook: Cyclical Tailwinds, Valuation Headwinds," which identifies the core tension in global markets for 2026: the economic cycle is still young, but the market cycle is already mature. This implies that despite persistently strong macroeconomic data, "high valuations" in segments of the equity and credit markets have become a vulnerability.

For investors, this creates a clear directional strategy: embrace cyclical assets that benefit from economic recovery but remain cheaply valued, while maintaining vigilance toward AI and large-cap technology stocks that have already seen substantial gains.

Specifically, emerging market equities, the Australian dollar, copper, and the U.S. capital goods and materials sectors have posted significant gains. In contrast, the previously leading AI/large-cap technology theme has encountered sharp volatility. Goldman Sachs suggests this cyclical rotation has further room to run.

Economic data remains robust, indicating markets have underestimated growth prospects. Growth figures continue to support cyclical asset performance. The U.S. ISM Index has risen steadily over recent months, the data surprise index has turned positive, and the labor market is showing signs of stabilization.

Globally, the January manufacturing PMI for developed markets hit its highest level in a year, while the emerging markets manufacturing PMI also increased month-over-month.

Goldman Sachs data indicates that market pricing for U.S. economic growth remains below the firm's full-year forecast of 2.5%. This suggests room for further upward revisions to cyclical expectations.

More importantly, beyond easing U.S. financial conditions and fiscal support, German fiscal expenditure is driving a recovery in German industrial momentum. Additionally, fiscal support in Japan is expected to strengthen following the ruling party's decisive election victory.

The market performance since 2026 exhibits two distinct characteristics. First is the sustained strength of non-U.S. equity markets. Second, sector performance isn't a simple cyclical/defensive split: commodities and industrial sectors have performed well, as have cyclical sub-sectors like U.S. homebuilders and regional banks, yet consumer staples have also shown strength.

This reflects a market reallocation from expensive technology stocks toward cheaper exposures, particularly in areas that have lagged in recent years, driving "value" to outperform "growth." However, the market is also rewarding cyclical exposures that benefit from the traditional global industrial recovery—capital-intensive old-economy sectors that have long suffered from underinvestment.

The persistent underperformance of U.S. stocks can be understood through these lenses: the U.S. market carries expensive valuations, has a heavier "growth" tilt, and traditionally has lower leverage to cyclical recoveries compared to other global equity markets like Japan, Europe, or emerging markets.

The backdrop for AI-related themes has become more challenging. Goldman Sachs acknowledges that the productivity gains from AI are real and the macro investment narrative still has room to develop. However, markets have overpriced these benefits, primarily focusing on companies directly involved in the AI boom, while attention has shifted toward debt-financed capital expenditure surges.

Although capital expenditure forecasts for hyperscale cloud providers have risen sharply, and new models and applications demonstrate increasingly powerful capabilities, these positive developments have triggered negative market reactions and sharp rotations from crowded positions.

Markets are concerned about cash flow consumption by hyperscalers and potential disruption to software providers and segments of the financial/real estate sectors.

Goldman Sachs notes extreme divergence within AI-related sectors. Given the pace of innovation, scale of investment, and the value already accumulated in AI-related tech stocks, volatility in this theme is likely to persist.

While core assets remain calm, peripheral markets are experiencing turbulence. The intense rotation within equity markets highlights another phenomenon emerging in 2026. Volatility for many core macro assets, such as U.S. interest rates, major developed market indices, and key currency pairs, remains subdued. Conversely, extreme divergence within U.S. equities, non-U.S. indices like South Korea's, and commodities like gold and silver are experiencing significant volatility.

Notably, although near-term U.S. equity index volatility is mild, longer-dated (1-year and 2-year) S&P 500 implied volatility has continued climbing to year-to-date highs. Goldman Sachs views long volatility positions—which are highly negatively correlated with equities and offer good liquidity—as a valuable portfolio supplement.

In credit markets, despite resilient January performance and well-absorbed record issuance, Goldman Sachs maintains a cautious stance. Higher volatility and potential large-scale revenue reallocation among companies and industries pose downside risks, while tight spreads may not offer sufficient compensation.

The U.S. dollar's depreciation has continued into 2026, but the drivers have broadened. Trends centered on the euro in the first half of 2025 and a focus on carry trades in the second half remain visible.

Simultaneously, dollar weakness against the euro resurfaced in January due to tariff concerns and worries about Federal Reserve independence. The underperformance of U.S. stocks relative to Europe and Japan has also provided fresh impetus for diversification and hedging discussions.

Currencies aligned with a global cyclical view—the Australian dollar, South African rand, Chilean peso, and Brazilian real, situated at the intersection of cyclical beta, commodity exposure, and cheap valuations—have posted the largest gains against the dollar.

Secondly, foreign exchange policies in several countries are receiving increased attention, particularly Asian currencies that have become very cheap relative to long-term valuations.

The investment strategy involves continuing to bet on the cycle, but selecting cheap options. Goldman Sachs' view is that markets still have room to raise growth expectations further. This tailwind should continue supporting cyclical currencies and traditional cyclical sectors, especially those with relatively cheap valuations. The increasing volatility and complexity surrounding the AI theme are likely to persist.

Although the most intense action may remain within major indices, it will likely periodically spill over into index-level volatility, gradually raising the baseline over time. This environment still supports diversifying equity holdings, maintaining healthy non-U.S. exposure (including emerging markets), and holding long positions in longer-dated index volatility.

In this context, core interest rates function more as hedge assets, particularly against a backdrop of moderate inflation. Following a recent rebound, the near-term risk skews toward yields moving higher again, especially if the U.S. labor market continues to stabilize.

For broader hedging, Goldman Sachs believes gold has further upside potential, as do energy prices, particularly if Middle East geopolitical risks escalate again.