Goldman Sachs: July Shakes Up Crowded Trades, US Stock Market Bull Run Continues but Becomes Harder

Author: Pan Lingfei, Wall Street Insights

In July, the US stock market did not experience a collapse at the index level but rather a liquidation at the position level. The S&P 500 held its ground this week, with a volatility range of only 3.5% throughout July, remaining less than 2% from its peak. Paradoxically, the equal-weighted S&P, low-volatility S&P, and the S&P 500 excluding AI all reached historical highs this week.

Tony Pasquariello, head of Goldman Sachs' hedge fund business, wrote in the latest market observation: "After experiencing a parabolic rise in high-speed trading, a heavy hammer has smashed through consensus positions over the past month; I tend to believe that this frenzy has cooled down." The focus is not on the disappearance of risk, but rather that the most crowded, easiest, and most leveraged trades have been forced to cool down.

A surface calm coexists with underlying volatility. The S&P 500 had an average daily volatility of less than 1% this week, while Goldman Sachs' flagship momentum basket had an average daily volatility close to 10%. On June 22, Goldman Sachs' TMT momentum basket had a year-to-date increase of 145%, followed by the most severe recorded drawdown, and then a single-day rebound of 17%. Asian fundamental long-short funds achieved record performance in the first half of the year, only to face the largest single-month drawdown in the past decade, while South Korea's KOSPI surged 18% overnight.

This framework leads to an uncomfortable conclusion: The outlook for the US stock market remains favorable, but the risk-reward ratio is no longer cheap, and the upside elasticity of global stocks is weaker than before. The bull market has not been declared out, but the next phase is not one of "buy and lie down to win."

Indexes Hold, Crowded Trades Collapse First

The most easily misjudged aspect of July is focusing solely on the S&P 500.

The index did not signal panic. The S&P 500 is less than 2% from its peak, and the volatility range in July was only 3.5%, appearing to be normal fluctuations. However, active managers have experienced a different market: hot momentum, AI chains, Korean stocks, and Asian long-short strategies have all been squeezed out of leverage.

The issue is not how much it drops on a given day, but that the previously most profitable trades suddenly lose liquidity. Betting on the S&P 500 itself shows stability; betting on high-momentum tech stocks reveals near-uncontrollable volatility.

The key split in July lies here: The index level is not turbulent, but the position level has already flipped over a batch.

Deleveraging is Not a Minor Adjustment, but a Real Cleansing

Several data points indicate that this round of deleveraging has exceeded ordinary portfolio adjustments.

Global tech exposure has experienced the largest sell-off in over five years. The asset management scale of South Korean leveraged ETFs peaked at $53 billion in June and has now dropped to $15 billion. The total exposure reduction seen by Goldman Sachs' prime brokerage is the largest since the end of 2022.

More detailed position changes point in the same direction: fundamental long-short clients' leverage exposure to momentum factors has dropped to the 28th percentile of the past year. Crowded trades have shifted from "everyone is on the bus" to a significant portion of people having gotten off, or even being forced off.

This does not mean that painful trades will not return. It simply means that compared to early July, the impulse to chase in the market has noticeably decreased, while cash and discipline have increased.

The Contradiction of AI Trading: From Narrative to Return Rates

In the latter half of July, AI trading faced not just simple profit-taking, but a more fundamental question: Can the massive capital expenditures by super-scale cloud providers in AI generate sufficiently clear and sustainable returns?

Last week, market skepticism about this question intensified. This week, the answers varied, but were better than the most pessimistic versions.

Meta did not demonstrate that significant AI returns have been realized; Microsoft provided clearer signals that capital expenditures are being converted into revenue and AI products, and at scale; Amazon subsequently reported a re-acceleration in AWS growth and an expansion in cloud business profit margins. The credit spreads of bonds from super-scale cloud providers have also narrowed.

These changes are significant. If AI trading is left with only "massive investment, distant returns," valuations will come under pressure; however, if some companies can prove that investments are starting to turn into revenue, the market will not treat the entire AI chain with a one-size-fits-all approach.

However, differentiation has already emerged. The previous phase where simply attaching an AI label could boost valuations is no longer as easy after this round of cleansing.

Fed Communication Becomes Murky, Long-Term Rates Resurface as a Stock Market Concern

After the FOMC meeting, stock market traders did not feel much relief. The volatility of the long end of the US Treasury curve briefly spilled over into the stock market.

The more troubling issue is the change in communication style. The market was accustomed to higher transparency, but now seems to have entered a more restrained and less explicit phase. Traders must judge policy direction with fewer clues, which inherently brings friction.

What truly needs to be monitored is the policy direction, not every word of phrasing. However, for stocks, changes in long-term rates cannot be ignored, especially for long-duration stocks. The valuations of AI, tech, and growth stocks are more sensitive to distant discount rates; if the long end of the global bond market continues to exert pressure, "stability at the base" does not mean comfort every day.

US Stocks Still Favorable, but Upside Elasticity Has Thinned

From a broader perspective, US stocks have not lost support. Economic performance is good, earnings growth is strong, and capital flows are expected to turn more positive, with nearly $1 trillion in AI capital expenditures still flowing through the system.

This explains why the S&P 500 can hold its ground amid significant deleveraging at the underlying level. The index is not without risk, but there are enough supporting factors to cushion it.

However, this is not a signal for aggressive bullishness. The direction of US stocks remains favorable, but the risk-reward ratio is at a mid-level, and the upside elasticity of global stocks is not as strong as in the previous phase.

Short-term volatility will continue. Summer liquidity is not conducive to risk transfer; once a certain type of position becomes crowded, illiquid, and structurally complex, volatility will be amplified. From a portfolio perspective, it is more suitable to increase liquidity and reduce complexity, rather than continue chasing the steepest trades.

Nasdaq Provides the Answer: The Bull Market Continues, but the Path Will Be Difficult

The Nasdaq 100 index has currently fallen 8% from its June peak, but is still up 12% year-to-date. Over the past nine months, it has seen six months of decline, yet point-to-point, it is still up 9%. The price-to-earnings ratio has fallen back to the lower end of the range seen in recent years.

These numbers clearly illustrate the market state: the trend is not bad, but the process is tough.

For trading, the endpoint and the path are not the same thing. The main bull market of the Nasdaq is still ongoing, but if the future continues to follow the rhythm of "rising for a while, smashing positions, then recovering," making money will be harder than simply being right about the direction. July has already given a reminder: the market does not reward crowded trades, nor does it forgive leverage.

This content is provided for general informational purposes only and doesn't constitute financial, investment, legal, or tax advice. Any events, rewards, online promotions, or related information mentioned herein should not be considered a recommendation, solicitation, or invitation to purchase, sell, trade, or otherwise deal in any crypto assets. Crypto assets are highly volatile and may result in loss. The availability of WEEX services, products, and related events may vary by region. You are responsible for ensuring that your participation is in accordance with applicable local laws and regulations.