Goldman Sachs hedge fund chief: Don’t fight, don’t chase rallies, stay rationally bullish on U.S. stocks
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As U.S. stocks fall for three consecutive days, Wall Street’s top traders say one should be “rationally bullish” on U.S. stocks.
“Don’t fight the market, don’t blindly chase highs.” Tony Pasquariello, partner at Goldman Sachs Global Markets and head of Hedge Fund Coverage, emphasized in an internal memo to clients.
So, what are his reasons for being “rationally bullish”? Pasquariello believes that, despite some recent market pullbacks, fund flows, historical experience, and the Federal Reserve’s policy moves all provide support for the market. He specifically points out that when the Fed cuts rates and the economy continues to grow, technology and consumer discretionary sectors tend to be the winners.
He emphasized that the market swings caused by doubts about AI “have been a feature of the past three years, not an anomaly.” As for China, he said, “This is another area that has shown notably strong performance.”
However, his optimism is not unconditional. Pasquariello remains skeptical about the long-term fundamentals of small caps and shows obvious caution toward European markets. He stresses that the current market environment is no longer a “rising tide lifts all boats” general rally, but an extremely selective “stock picker’s market” that tests one’s ability to pick stocks.
In the memo, Pasquariello laid out 18 core themes facing the current market, covering topics from fund flows and U.S. labor markets to stock market performance across Europe, Japan, and other regions.
1. Fund Flows and Market Positioning
Fund flows last week were clearly very positive: hedge funds recorded their largest U.S. stock purchases in three months... long-only funds were also buying, especially tech stocks... and derivatives markets fueled the fire, with surging demand for call options and the upward pull of quarterly expiration.
Looking at this week’s developments, prime brokerage activity is now noticeably less frenzied, with the trading community eyeing an estimated $20 billion in end-of-quarter supply. With Q3 earnings season approaching, stock buyback activity is dwindling, leaving U.S. retail investors to shoulder the burden of supporting the market.
2. U.S. Labor Market
Given recent employment data, it’s hard not to worry about certain trends, especially amidst ongoing AI development. While I don’t dismiss these concerns, a look back at history tells an interesting story: there were several negative job reports in the U.S. in the mid-to-late 1990s—1995, 1996, 1998, and 1999—and those were NOT times to be bearish on stocks.
3. Sector Strategies
Inferring from this, when the Fed cuts rates while the economy keeps growing, which sectors should you own? The answer is: tech and consumer discretionary.
4. Nasdaq 100 Index
A few weeks ago, I mentioned the performance of the Nasdaq 100 since early 2009 (noting that earnings and dividends explained 90% of the rise). Many people asked: what if we’re not starting from the lows? A reasonable question. As you can see, the overall conclusion remains the same—this is not a story of excessive P/E expansion.
5. Small Caps
Yes, small caps have performed very well over the past two months. Yes, given what’s happening, that makes sense: the Fed is cutting rates amid a cyclical upturn. Yes, there are still short positions feeling the squeeze. No, I don’t like the fundamentals of this asset. My take is: there was a window of opportunity in small caps—some people I know caught it well—but I think it’s only temporary. In other words: I would not be tempted to see this as the start of a major trend.
6. Hedge Funds
Among all the complex factors, I find the YTD performance of fundamental long/short funds very solid: total return +12%, with more than 5% alpha. Note: this was achieved with only moderate net risk exposure.
7. Options Market
A feature of the recent rally: as the market makes higher highs, implied volatility remains high. Why? Maybe history reminds us: October, on average, is the most volatile month of the year. More practically, I think this is due to surging demand for right-tail (upside) exposure, especially in single names.
It might be annoying, but I still think, when the market offers cheap gamma, you should grab some.
8. Europe
After a strong start to the year, the Euro Stoxx 50 Index (SX5E) has barely budged over the past four months (in fact, the high was set in early March).
Here are some reasons I’m skeptical: (1) Defense stocks surged again, ASML jumped 25% in a month, but the index was flat; (2) Unlike the U.S., Europe’s rate cycle is done; (3) If anything, the prior point pushed EUR/USD higher, possibly pressuring EU profits; (4) We see this market being sold across several dimensions in our business. Again, happy to hear differing views (I might regret saying that).
9. Japan
In contrast, the Nikkei 225 and TOPIX are trading well (the charts look great). A few key points: (1) with the October 4th election approaching, remember LDP departures have usually been a net positive for domestic stocks, (2) the fact remains: this market is making higher highs, but still has not fully regained lost ground from last summer’s turbulence; (3) Note: Goldman Sachs Global Investment Research has raised its target price.
10. China
This is another area showing notably strong performance. I am tactically open-minded—for example, Alibaba’s recent stock movement—but remain cautious over the long term.
11. Momentum Stocks
As part of the rally in some volatile segments of the recent market, here’s the price trajectory of one of our momentum baskets. I don’t really know what to think—I tend to view momentum as a factor worth being structurally long, but there’s reason to question this rally’s sustainability.
12. Robotics
You’ve seen this before—Goldman Sachs’s China Bionic Robotics basket. Here I’ll share Rich Privorotsky’s view... The U.S. and China are now in a tech “space race.” (This is the bionic robotics stock basket chart)
13. Artificial Intelligence
At a time when the AI narrative is facing some skepticism, Pasquariello uses Goldman’s U.S. AI leaders vs. laggards pair trade to show the field’s development. He emphasized: "I’m highlighting this now—when the AI story faces doubts—to show these swings have been a feature of the past three years, not an anomaly."
14. “Stock Picker’s Market”
This is a chart of 3-month realized S&P 500 correlations. “This is a stock picker’s market,” providing active managers with more alpha opportunities.
15. Real Yields
Despite recent market turmoil—and its accompanying narrative shifts—note that U.S. real yields have held within a range. YTD real rate compression has been favorable for stocks. (Here’s the real yield range chart)
16. Dollar Weakness
I think this is an interesting overlay chart. On the one hand, I assume global central banks’ dollar reserves will keep trending down. Then again, this doesn’t necessarily mean the outlook for the dollar is overwhelmingly negative. (Here is the Dollar Index vs. central bank reserves overlay)
17. Yield Curve vs. Credit Spreads
It’s clear the U.S. Treasury yield curve is steepening—a visible trend—yet credit spreads for different corporate bonds are moving in the opposite direction.
18. Mortgage Swirl
Last chart: the distribution of rates on outstanding 30-year mortgages (credit: Jessica Rindels). One could argue that homeowners who bought in recent years should quickly refinance when rates fall—but the fact is, 80% of mortgage borrowers have rates below current levels.
I’m not saying lower mortgage rates wouldn’t be good—just that, before this becomes a widespread story, there’s still a ways to go.
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