Strategic Diversification for Risk-Adjusted Returns in Late-Cycle Environment

In this conversation from Goldman Sachs' "Exchanges" podcast, Peter Oppenheimer, Kamakshya Trivedi, Daan Struyven, and Christian Mueller-Glissmann map the complex interplay of global economic trends, market cycles, and asset allocation for 2026. The core thesis reveals that while a positive economic outlook and moderating inflation might suggest a straightforward path for risk assets, the reality is far more nuanced. Hidden consequences emerge from stretched market valuations, the evolving AI theme, and the strategic imperative of diversification in a late-cycle environment. Investors who can look beyond immediate gains and embrace a longer-term, diversified approach, even when it involves embracing current discomfort or complexity, stand to gain a significant advantage. This analysis is crucial for portfolio managers, institutional investors, and sophisticated individual investors seeking to navigate a landscape where conventional wisdom often fails to account for the cascading effects of market dynamics.

The Shifting Sands of Equity Cycles: Beyond Optimism's Edge

The prevailing narrative for 2026, as painted by Goldman Sachs strategists, is one of an extended economic growth cycle, tempered by moderating inflation and a potential easing of interest rates in key economies like the US. This backdrop, Peter Oppenheimer notes, is generally "pretty good for risk assets like equities." However, he cautions that this positive outlook is layered with complexities, particularly concerning market valuations, which are described as "quite high." The conversation pivots from a simple forecast of growth to a deeper dive into the equity cycle, moving beyond the current "optimism phase" to consider the inevitable subsequent "despair phase."

Oppenheimer’s analysis highlights a critical system dynamic: the cyclical nature of market sentiment and its drivers. The historical pattern of despair (bear market), hope (explosive valuation rises), growth (profit expansion), and optimism (valuations rising alongside profits) suggests that even a prolonged optimism phase will eventually give way. The implication for investors is clear: relying solely on the current positive sentiment is a risky proposition. The AI theme, while a powerful engine of growth, is also evolving. Oppenheimer predicts a "broadening out" beyond the infrastructure providers to the application layer and companies benefiting from increased productivity and energy generation. This shift implies that investors must constantly reassess which segments of the AI theme offer sustainable growth, rather than chasing the initial wave.

The US equity market, despite strong absolute returns, underperformed non-US markets in 2025. This underscores a crucial point about diversification. Oppenheimer emphasizes that diversification is not just geographical but also sectoral. As technology's dominance wanes, other sectors are poised to benefit from AI and technological advancements. The delayed payoff for investors who diversify across regions like EM and Northern Asia, or sectors like financials and industrials supporting AI infrastructure, could create a significant competitive advantage. This requires patience, as these regions and sectors may not offer the immediate, headline-grabbing returns of the US tech giants.

"What we find is that each cycle repeats itself, not in exactly the same way, of course, it has its distinct features and drivers, but you do tend to get specific phases of the equity cycle which are driven by different factors."

-- Peter Oppenheimer

This insight suggests that conventional wisdom, which might favor established, high-performing markets, fails when extended forward without considering the cyclical nature of markets and the broadening opportunities elsewhere. The true advantage lies in anticipating the rotation and the benefits of diversification, even if it means accepting lower immediate returns for more robust long-term risk-adjusted performance.

The Dollar's Slow Descent and the Anchored Yield Curve: A Tale of Two Cycles

Kamakshya Trivedi’s analysis of currencies and interest rates introduces another layer of systemic complexity, particularly concerning the US dollar and bond yields. Despite a positive global macro outlook, the dollar is expected to depreciate, albeit at a slower pace than in the previous year. Trivedi notes that the dollar remains overvalued, and a "broad pro-cyclical environment" favors currencies that perform well during periods of buoyant growth and rising commodity prices. This implies that the dollar's trajectory, while seemingly a straightforward consequence of economic conditions, has downstream effects on global trade and investment flows, potentially benefiting emerging market currencies and assets.

The interest rate outlook is characterized as the "tail end of global easing," with only the US Fed and the Bank of England expected to deliver further rate cuts. A majority of central banks are anticipated to hold rates steady. This scenario, coupled with a broader disinflationary trend, is expected to keep inflation anchored and bond yields well-contained. This is a critical divergence from past concerns about fiscal risks leading to rising bond yields.

"Ultimately, though, we think that there's going to be a kind of broader disinflation playing through much of this year. I think all of those factors should keep inflation low, should keep inflation anchored, and should allow these central banks to stay on hold."

-- Kamakshya Trivedi

The consequence-mapping here is vital: anchored inflation and stable, albeit range-bound, bond yields mean that growth becomes the primary driver of bond price movements. This allows bonds to act as a more effective hedge against long equity or risk asset portfolios. However, Trivedi also points out a significant tension: market valuations, particularly in equities and credit spreads, feel "much later cycle than the macro." This disconnect suggests that while growth may continue to drive risky assets higher, the journey could be accompanied by higher volatility. The immediate comfort of low rates and steady growth might mask the underlying fragility of stretched valuations, where a shock or deterioration in macro momentum could trigger significant drawdowns. The conventional approach of seeking yield through credit, Trivedi warns, is problematic in this late-cycle environment due to tight spreads and poor convexity, suggesting that the "discomfort" of avoiding carry trades in favor of equity exposure with better convexity is a strategic necessity.

Commodities in the Crosshairs: AI's Energy Demand and Gold's Geopolitical Shield

Daan Struyven’s examination of commodity markets reveals how geopolitical forces and technological shifts are reshaping traditional supply and demand dynamics. Gold, in particular, is presented as a high-conviction investment, driven by structural increases in central bank demand and cyclical factors like Federal Reserve cuts. Struyven highlights a significant, often overlooked, consequence of geopolitical events: the freezing of Russia's reserves has normalized higher central bank gold buying as a hedge against sanctions. This structural shift, combined with potential private sector diversification, suggests a durable upward trend for gold prices, offering a hedge against geopolitical risk and currency internationalization efforts by emerging market central banks.

The outlook for oil, however, is more bearish in the short term, with prices expected to trend lower due to an oversupplied market. Struyven identifies potential supply disruptions and OPEC+ actions as key variables, but his base case anticipates downside unless these factors materialize. The infrastructure degradation in Venezuela, despite its historical production capacity, means that a quick recovery is unlikely, adding a layer of complexity to supply-side predictions.

The most compelling systemic insight from Struyven concerns the impact of AI on energy markets. The "best commodity AI trade" is identified as long US power markets, specifically in localized areas where data centers are concentrated. The direct and substantial demand boost from data centers is outpacing GDP growth in the US, creating localized scarcity. This is compounded by supply-side constraints in power grids, which require years of investment.

"The demand boost from data centers to power demand is very direct and very big. For the first time since the '70s, US power demand is outpacing GDP growth."

-- Daan Struyven

This creates a situation where "higher power prices are needed to incentivize the supply to prevent running out of power." The implication is that the immediate, localized pain of soaring power costs is a necessary precursor to long-term investment and grid expansion, a classic example of immediate discomfort yielding future advantage. Investors who can anticipate these localized energy demands and supply constraints stand to benefit from a trend that is fundamentally reshaping energy consumption patterns.

Navigating Late-Cycle Portfolios: Diversification as a Durable Advantage

Christian Mueller-Glissmann synthesizes these market dynamics into actionable portfolio strategy, emphasizing the importance of diversification in a late-cycle environment. He notes that while investor sentiment is bullish, it lacks the "excessive optimism" that typically signals a market top. However, he flags elevated equity allocations in many portfolios, driven by strong past performance rather than active buying. This concentration presents a significant drawdown risk, even if valuations are partly justified by structural optimism around AI and favorable cyclical factors like low unemployment and high profit margins.

Mueller-Glissmann’s core message is that in a late-cycle backdrop, diversification is the primary tool for adding value and creating a robust portfolio. This contrasts with market timing, which is notoriously difficult, especially when trying to pinpoint the peak of a bull market. He points out that the last six months of a bull market can deliver substantial gains, mirroring losses in the early stages of a bear market, making it crucial to "stay invested and manage the risk."

The conversation highlights a key tension: while equities are favored for their potential convexity and ability to benefit from structural optimism, traditional "carry trades like credit" are to be avoided. Credit, with its "poor convexity and poor asymmetry," is highly susceptible to recession scares, and spreads are tight. This means that the immediate reward for taking on credit risk is limited, while the downside is substantial.

"As an asset allocator, you have two major tools to add value in the portfolio: either market timing or diversification. And what we would argue is in a late cycle backdrop, you should focus on diversification, creating a robust portfolio that can deal with shocks and that can let you stay invested..."

-- Christian Mueller-Glissmann

This strategy requires investors to embrace a degree of "discomfort" by potentially foregoing the seemingly easy gains from credit, opting instead for the more resilient, albeit less direct, path of equity exposure and diversification. The discussion also touches on alternatives as a means to enhance diversification, as they are often less correlated with public market cycles. The low levels of realized volatility across various assets also present opportunities for selective hedging. The overarching theme is that building a resilient portfolio in 2026 requires a strategic shift away from chasing immediate yield towards a more diversified, risk-aware approach that prioritizes long-term stability and adaptability.

Key Action Items

• Diversify Equity Exposure Geographically: Over the next quarter, actively rebalance portfolios to increase allocations to regions like EM and Northern Asia, which are forecast to have stronger growth prospects and benefit from a weaker dollar.
• Broaden Sectoral Investments in Equities: Within the next six months, identify and invest in sectors beyond technology that are poised to benefit from AI infrastructure build-out (e.g., industrials, energy) and companies driving AI applications.
• Re-evaluate Credit Holdings: Immediately review and reduce exposure to traditional credit carry trades, particularly where spreads are tight. Prioritize moving up the risk curve via equities with better convexity.
• Explore Alternative Investments: Over the next 6-12 months, investigate and selectively increase allocations to alternative asset classes that offer lower correlation to public markets and can enhance portfolio diversification.
• Consider Gold as a Strategic Hedge: Within the next quarter, assess increasing gold holdings as a hedge against geopolitical risk and currency internationalization trends, recognizing its structural demand drivers.
• Monitor Localized US Power Markets: For investors with direct commodity exposure, identify opportunities in localized US power markets where data center demand is driving significant price appreciation and potential for further gains over the next 12-18 months.
• Embrace Delayed Payoffs: Recognize that strategies focused on diversification and less correlated assets may not show immediate spectacular returns but are designed for resilience and long-term advantage, paying off in 18-36 months by preserving capital during market downturns.