Is inflation overheating again?

The next AI investing phase # # --------------------------------------------------------------- The key takeaways today: - What markets may be missing about inflation data - The next phase of AI investment - European pension funds are leaning into sustainability - The last mile of the soft landing may be the most difficult - The $13 trillion insurance investors are cautiously upbeat about the US economy - Briefings Brainteaser: Which US city has seen the smallest increase in office vacancy rates? Was this newsletter forwarded to you? [Sign up now](. --------------------------------------------------------------- Markets may be worrying too much about overheating inflation The market's reaction over the prospect of sticky inflation is likely overblown, says David Mericle, Goldman Sachs Research's Chief US Economist. The largest recent upside surprises in the inflation data are examples of lagging indicators or “catch-up inflation,” such as car insurance and owners' equivalent rent. “The key point here is that that catch-up eventually comes to an end,” Mericle says on [Goldman Sachs Exchanges](. “What we are not seeing is a reigniting of overheating inflation. We are not seeing a retightening of the labor market, an increase in wage growth, a worrying rise in inflation expectations,” he says. “The problems that would give you a sustained inflation problem…were solved quite a while ago.” David Mericle (L), Chief US Economist, and Allison Nathan of Goldman Sachs Research Meanwhile, the outlook for US economic growth remains relatively solid, according to Mericle, who expects US GDP to grow 2.5% year on year in the fourth quarter of 2024. Over the medium-term, interest rates are likely to settle at a higher level than in the last cycle. Goldman Sachs economists have long argued that the neutral rate (at which the economy is at full employment, and the policy rate neither stimulates nor slows GDP growth) was not quite as low as the conventional wisdom held during the last cycle. For now, the short-run neutral rate might be higher than the long-run neutral rate because fiscal deficits are much wider than usual, resilient risk sentiment has limited the transmission from higher rates to broad financial conditions and the economy, and the most rate-sensitive sectors (housing and autos) have been constrained more by supply than demand. All these factors help the economy remain at full employment despite higher interest rates. Fed officials are likely to raise their estimates of the neutral rate over time, though by how much remains uncertain. --------------------------------------------------------------- AI infrastructure stocks are poised to be the next phase of investment Investor enthusiasm for AI has boosted the US stock market to new highs, led by Nvidia, the maker of specialized chips used to run generative AI models. Now a key question for investors is what happens next as the AI rally broadens to involve more companies, [according to Goldman Sachs Research](. If Nvidia represents the first phase of the AI trade, Phase 2 will be about other companies that are helping to build AI-related infrastructure. Phase 3 deals with companies incorporating AI into their products to boost revenue, while Phase 4 is about the AI-related productivity gains that should be possible across many businesses. Read [our article]( about the four phases of AI investment. --------------------------------------------------------------- European pension funds are leaning into sustainable investing Sustainable investing has become an ingrained feature in European pension funds, [according to the European Pension Survey 2024]( published by Goldman Sachs Asset Management. For 87% of the respondents in the survey, sustainability is a critical or important factor in their investment decisions. Around 45% say they allocate a fifth of their portfolio or more to sustainable investments. The survey, conducted in November and December 2023, polled 126 senior defined benefit pension fund managers, whose assets under management ranged from less than $500 million to more than $50 billion. Of the asset classes in which respondents incorporate sustainable investing strategies, developed market equities and investment-grade debt top the list. These include screens to exclude investment in specific products and countries, as well as companies engaging in certain types of conduct. Respondents also tilt their portfolios based on environmental and governance criteria. “The results also reflect the obstacles that still exist for sustainable investors, notably the shortage of reliable, relevant data in some areas of the market,” says Edith Siermann, Goldman Sachs Asset Management BV's chief investment officer and global head of sustainability in fixed income. “In our view, the availability of high-quality data helps explain why developed market equities and investment-grade debt top the list of asset classes where respondents have implemented sustainability tilts.” Nearly one-third of respondents say their primary reason for implementing a sustainable investing approach is to fulfill their fiduciary responsibility, while one-fifth cited risk mitigation. Most respondents believe that integrating ESG criteria into investment decisions can help reduce long-term risks, and more than half say this approach can generate higher returns. --------------------------------------------------------------- Confidence in the economy is building — but there's no room for complacency A third of the way into 2024, growth remains resilient, and financial conditions are loosening. Signals suggest corporate sentiment is improving, and M&A activity has recovered from rock-bottom levels. But it's hard to have absolute confidence that the inflation fight has been won, Goldman Sachs Asset Management finds [in its latest issue of Asset Management Perspectives]( and the risk of recession has not completely disappeared. Unresolved conflicts, geopolitical competition between nations, and upcoming elections around the world continue to present uncertainties. It's an environment offering reasons for caution, but also some optimism. - The approaching runway. The US economy appears to be gliding toward a soft landing, but the last mile may be the most difficult part of the journey. “Against this backdrop, we favor a balanced approach across equities, fixed income, and alternatives, which is expected to provide diversified sources of returns, as well as hedges against potential risks,” [write Alexandra Wilson-Elizondo and Amy Zhou](. A soft landing would be good for both government bond and equity investors. But alternative exposures, such as private credit, investment-grade corporate bonds, and global bright spots such as Europe, Japan, and India may help insulate portfolios from volatility. - High concentration. Close to a third of the value of the S&P 500 index lies in the Magnificent Seven tech stocks, raising concerns about overexposure and over-concentration. But that alone shouldn't justify moving out of these tech stocks. “The performance of today's top companies has been underpinned by solid corporate balance sheets, strong earnings, and potential for robust future growth from AI-driven innovation,” [Goldman Sachs Asset Management finds](. “Prudent investors should therefore consider ways to maintain a diversified portfolio to mitigate idiosyncratic risk along with a bias towards quality in their portfolio.” This diversification might include opportunities such as private investing or markets outside the US, such as the GRANOLAS group of 11 companies that dominate Europe's equity indices. - AI in Portfolios. As AI reshapes economies and industries, the range of investment opportunities and risks will expand. “Investors who find ways to successfully balance the dual dynamics of investing in and with AI, while navigating an unpredictable AI future, are likely to be among the long-term winners,” [Goldman Sachs Asset Management finds](. The first beneficiaries have been the “enablers” — companies building necessary AI infrastructure. Tomorrow's potential beneficiaries may be found in the “data and security” layer and, lastly, among the “applications” — software companies and firms across sectors leveraging AI to improve their products and services. Investors may benefit from evaluating how AI breakthroughs are helping to enhance investment management processes and investment decision-making. Still, for some investors, there may be unforeseen twists given the velocity with which the market is currently moving. But Goldman Sachs Asset Management believes that those who have access to resources and the infrastructure in place to harness data effectively may have a competitive advantage in the years ahead. --------------------------------------------------------------- Insurance investors are cautiously upbeat about the US economy Insurance companies are slightly more sanguine about inflation and monetary tightening compared to last year, [according to Goldman Sachs Asset Management's 13th annual Global Insurance Survey](. And their appetite for credit risk — particularly private credit allocation — is growing. The survey, which surveyed 359 CIOs and CFOs representing $13 trillion in balance sheet assets, illuminates insurers' views on economic growth, asset allocation decisions, expectations of returns, and portfolio construction. Some of its key numbers: - 53%: Insurers who believe private credit will deliver high total returns over the next 12 months. - 42%: Insurers who are looking to extend the duration of their portfolios. Investor confidence “rests upon two important pillars: the expected beginning of Federal Reserve rate cutting and waning recession fears,” says Matthew Armas, global head of Goldman Sachs' Insurance Asset Management. - 80%: Insurance companies that are actively using or considering the use of AI technologies. These firms are employing (or planning to employ) AI to reduce operational costs, evaluate investments, or underwrite risks. - 86%: Insurers for whom ESG and / or impact investing is a consideration, and who view environmental goals as a focus. Listen to [our Goldman Sachs Exchanges episode]( for more on the results of the Global Insurance Survey. --------------------------------------------------------------- Briefings Brainteaser: City lights Since 2019, the US office vacancy rate has risen the most in cities that have higher shares of workers whose work can be done remotely. San Francisco had the highest such share, with close to 65% of workers in information, finance, and professional services. Which of these four cities had the lowest such share, and thus saw the smallest change in office vacancy rates? A) Houston B) Chicago C) Washington DC D) Los Angeles [Check the answer here](. --------------------------------------------------------------- Goldman Sachs in the news By clicking on these links, you will redirected to external websites that Goldman Sachs does not own or operate. Goldman Sachs is not responsible for the products, services, or content provided on those sites. 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