Wall Street Banks See Year-End Rally, But Inflation Risk Looms

Wall Street Banks See Year-End Rally, But Inflation Risk Looms

TREE NEWS reports: Goldman Sachs, Morgan Stanley, and JPMorgan have all signaled a potential year-end rally in US stocks, citing extreme positioning washout, valuation reset, and seasonal factors. However, a looming inflation threat could derail the rally and force the Federal Reserve to hike rates again.

Positioning Washout Sets Stage for Squeeze

Goldman Sachs strategist Cosimo Codacci-Pisanelli argues that the recent selloff has been one of the most aggressive deleveraging episodes in a decade. Net and gross positions in Goldman’s prime brokerage book have shrunk sharply, and Morgan Stanley data shows hedge funds are now underweight AI stocks for the first time since 2023. JPMorgan told clients that sentiment is “quite bad—which should be a bullish signal.”

Goldman notes that the market absorbed multiple negatives in a single week—stronger-than-expected CPI, hawkish Fed rhetoric, rising rates, higher oil prices, and negative Nvidia news—yet prices remained relatively stable, suggesting selling pressure is exhausted.

Valuations Back to Historical Averages

After the multiple contraction, global equities trade near their 35-year average. The MSCI All-Country World Index’s 12-month forward P/E has fallen to 15.6x, with a PEG ratio of 1.1x, both close to historical averages since 1997. Earnings expectations have not been revised down; instead, consensus EPS for 2026, 2027, and especially 2028 has been upgraded at an above-average pace. Goldman notes that the 2028 earnings curve “looks more like a meme stock than an earnings forecast line.”

With real rates at 2.25%, Goldman’s regression implies a fair P/E of 18.9x for the S&P 500, versus the current 17.9x—about one multiple point below the regression line.

Inflation Pipeline Pressure Exceeds Pandemic Peak

However, the report warns of a more troubling undercurrent. US CPI has exceeded expectations in both September and October, with broad-based upside. Global manufacturing import price inflation, annualized over six months, is running at about 24%—well above the 2021-2022 pandemic peak. Global producer price inflation is around 11% annualized. The diffusion is widening beyond energy and AI hardware to chemicals, plastics, and paper products.

In the US, Germany, France, Italy, and the UK, the share of import price categories with annualized gains above 5% has jumped to 25-40%; in US producer prices, that share exceeds 40%, a level last seen before the 2021-2022 inflation wave.

Goldman notes that companies are still absorbing input cost increases by compressing margins, but the key question is how long that buffer can last. Upstream price pressures typically take 6-12 months to fully pass through to consumers, meaning the bill will come due in the first quarter of next year.

January Is the Real Test

Goldman’s data shows that January is the month with the most concentrated price resets: about 16 components see price jumps exceeding two standard deviations, versus no more than 2.5 in other months. European markets show similar seasonality, with January core HICP often posting the largest monthly gain of the year since the pandemic.

Against this backdrop, Goldman economists have added a third Fed rate hike to their forecasts after the latest CPI data. Codacci-Pisanelli also points out a reflexive loop: central banks have been dovish partly due to equity market declines and credit tightening. If stocks stabilize and financial conditions loosen, the rationale for staying on hold disappears.

In other words, a year-end squeeze would borrow from future returns, and the party could be followed by a hangover. Goldman explicitly recommends: “Long front-end inflation is a good complement to portfolios.”

Goldman itself admits that 2026 will be “extremely difficult for macro traders, with pitfalls in almost every asset class,” and that the most useful rule in hindsight is to “short every consensus trade.”

As Codacci-Pisanelli writes: even if Santa Claus arrives, the bill from energy-driven intermediate PPI—which has outpaced final demand prices by a factor of two—and manufacturing import prices rising faster than during the pandemic will be delivered on time in the first quarter, regardless of whether the rally materializes.

“Good luck,” the report concludes.

Key Takeaways

• Major Wall Street banks see conditions for a year-end rally, but the trade is becoming crowded.
• Inflation pressures are building faster than during the pandemic, with January price resets likely to force the Fed’s hand.
• Investors should be wary of chasing the rally and consider inflation hedges as the bill comes due in Q1.