Stocks have not yet bottomed and investors should be prepared for flat returns through 2023, Goldman Sachs says

• Despite a relief rally this month, Goldman Sachs says the stock market has still not bottomed out.
• Investors should have less exposure to stocks and bonds in the near-term, the bank wrote in a note on Monday.

Stocks have enjoyed a strong relief rally in November after the October inflation report showed prices cooling, but the market has still not bottomed and investors should be prepared for flat returns through 2023, Goldman Sachs said in a note on Monday.

After inflation surged to 40-year highs this year, markets celebrated signals that the Federal Reserve may soon pull back on interest rate hikes, as cooling prices could allow for less aggressive policy. The S&P 500 is up 3.2%, while the Dow Jones Industrial Average has increased 4.52% in the past month.

But the party isn't going to last, according to Goldman Sachs strategist Christian Mueller-Glissmann, and there are a number of conditions that have still not been met in order for a market bottom to form.

"Without depressed valuations, for markets to trough investors need to see a peak in inflation and rates, or a trough in economic activity," Mueller-Glissmann said in a note on Monday. "The growth/inflation mix remains unfavorable – inflation is likely to normalize but global growth is slowing and central banks are still tightening, albeit at a slower pace."

As stocks are overvalued and economic conditions remain shaky, investors should consider allocating further to cash and credit, and have less exposure to stocks and bonds in the near-term. Both equities and fixed-income securities may experience "further headwinds" from potential rate hikes and uncertain economic growth, while the investment bank expects the US dollar to hit a peak in 2023.

Muelle-Glissman added: "The valuation starting point has improved but risky asset valuations are well above recessionary levels and earnings are skewed to the downside next year. And the recent relief rally on peak inflation/hawkishness hopes has reduced risk premia on cyclical assets again."

Next year, bonds could serve as a decent diversification tool because they will be less correlated with equities. If central banks continue tightening, however, bonds will not be able to be a "reliable buffer for risky assets" like stocks.

"With low expected returns and limited diversification benefits from traditional assets, the case for larger allocations to alternatives and focus on alpha rather than beta remains strong," Mueller-Glissmann wrote.