Recent declines in US stocks were driven by high investor expectations at the beginning of the year as well as concerns about weaker economic growth and uncertainty created by President Donald Trump’s tariff announcements. Even after the drop, the S&P 500 might be vulnerable to deeper declines, according to Goldman Sachs Research.
US stocks fell in early March, with the S&P 500 posting a correction (a drop of 10% or more from peak to trough) as of March 27 after reaching an all-time high on February 19. In spite of the steep selloff, our strategists’ equity drawdown risk model, which forecasts the probability of the S&P 500 falling, suggests US stocks are at risk of further declines. The model has indicated an elevated risk of the equity losses since January.
“The equity drawdown probability hasn’t peaked yet,” says Christian Mueller-Glissmann, head of asset allocation research within portfolio strategy for Goldman Sachs Research. The model looks at both macroeconomic and market variables, and those factors do not appear to have reached a point of balance. “As the markets have gone down, the macro backdrop has also deteriorated. And that means that you cannot sound the all-clear at this point. There’s still a risk of the equity correction continuing — even though we do not expect a bear market, as this usually requires a recession,” he adds.
But Mueller-Glissmann also notes that the equity drawdown model is unlikely to anticipate changes in policy, such as adjustments to interest-rate policy from central banks. “So if there’s a major policy pivot from President Trump or the Federal Reserve, of course, markets could recover much faster.”
Why did US stocks fall?
Mueller-Glissmann’s team looks at three different cycles in its analysis of markets: the sentiment cycle, the business cycle, and the structural (economic) cycle. Sentiment has been particularly important in stock markets so far this year.
The structural cycle, which describes trends in the wider economy, is often closely linked to the business cycle — the performance of the economy and companies. But sentiment — the attitude of investors towards a certain stock, sector, or market — is often behind short-term market movements.
The performance of equity markets has defied the expectations of many investors, both because of the decline in US stocks and because of the relative outperformance of European and Chinese stocks.
“This reversal was accelerated and exacerbated by the sentiment going into 2025” Mueller-Glissmann says. “Positioning was very bullish at the beginning of this year with regards to the US. The reverse was true of Europe and China: People were structurally bearish because of headwinds from housing, demographics, and geopolitical concerns in China, and because of political gridlock and lower productivity in Europe.”
The correction in the US, meanwhile, has been led by the major large cap technology stocks known as the Magnificent Seven, which have dropped significantly more than the rest of the S&P 500 Index.
“That’s important, because the Magnificent Seven are also drivers of confidence for retail investors (i.e. for households). We find that household allocation to equities in the US is the highest ever — even higher than during the tech bubble,” Mueller-Glissmann explains. This means that sentiment in the US equity market might be particularly sensitive to a drop in the value of Magnificent Seven stocks.
One way of assessing investor sentiment is by looking at risk appetite as indicated by markets. “What we’ve found historically is that if our risk appetite indicator is very negative, irrespective of what happens in the business cycle, at some point you can buy the dip,” Mueller-Glissmann says.
Normally, the risk appetite indicator needs to register close to -2 before investors can expect a reversal in market performance without a change in the momentum of the wider economy or policy support. And while the indicator is currently well above that level, things can change quickly.
A good example was during the summer in 2024, when the risk appetite indicator fell to -2 in a matter of days after the start of the equity downdraft, creating a good buying opportunity for investors, who could look for a market recovery shortly after.
“Normally, when we have an equity correction, I’m looking either for the risk appetite indicator going to -2 or our equity drawdown risk model — which incorporates macro momentum, policy shifts, and also the risk regime — starting to peak. We don’t have either yet. And that tells us that, in the near term, things could remain quite bumpy,” Mueller-Glissmann says.
What’s the outlook for the 60/40 portfolio?
At the beginning of the year, when the equity drawdown risk indicator was suggesting an elevated risk of a correction in US stocks, the portfolio strategy team cautioned that investors should diversify portfolios both across and within assets. Diversifying across assets means balancing out equity exposure with bonds; diversifying within assets means investing in equities from non-US markets.
But Mueller-Glissmann adds that the 60/40 formula for buy-and-hold portfolios — comprised of 60% equities and 40% bonds — has continued to perform well so far this year.
“Equities are down in the US, but bonds have rallied in the year to date. And in Europe, bonds are down, but equities have rallied,” Mueller-Glissmann says. This means that an average portfolio comprised of both assets from either region was diversified enough to keep yielding returns in spite of the volatile start to the year.
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Historically, it’s unusual for non-US equities to decouple from their US counterparts, Mueller-Glissmann adds. This means that a continued decline in US stocks could start to affect global equities more broadly.
“What tends to happen is, maybe on the first instance as US equities sell off for the first 5-10%, European and global equities can outperform, like they have for the last few weeks,” Mueller-Glissmann says. “But then, if US equities go through a larger correction, the rest of the world tends to catch down.”
“As a result of that, you now want to think about diversifying not just regionally, but also across styles,” he adds. In particular, this includes low-volatility stocks — equities from more defensive sectors, which tend to fluctuate less than the rest of the market.
In the first two weeks of March, low-volatility indexes in Europe and the US materially outperformed other stocks in both regions. This marks a break from a spate of poor performance from low-volatility indexes since the time of the Covid pandemic.
Optimism about growth recovering in the wake of the pandemic coupled with rising bond yields has weighed on defensive sectors, which tend to have more debt and thrive in less optimistic market environments.
Now, Mueller-Glissmann says, both of those factors are starting to work in favor of low-volatility stocks, “because the market is getting a bit less bullish, and bond yields have come down a bit — especially in the US.”