Goldman Sachs: The AI narrative is becoming increasingly complex and speculative leverage is intensifying, but we recommend "continue holding, streamline your positions."

Goldman Sachs: The AI narrative is becoming increasingly complex and speculative leverage is intensifying, but we recommend "continue holding, streamline your positions."

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The main US stock indices remain near their highs, but the internal trading structure of the market has become more crowded and turbulent.

"The characteristics of the market have clearly changed." On July 8 local time, Tony Pasquariello, head of Goldman Sachs’ hedge fund business, observed in his latest market commentary that since hitting a high in early June, the S&P 500 has been consolidating in a highly volatile range. As Q2 earnings season progresses and summer liquidity shrinks, this turbulence will continue, and the path will become more bumpy.

His advice is: The main bull market trend remains unchanged, but the path will be "broader and bumpier"—"Don’t get off easily (stay in the saddle), but simplify your positions, focus on your highest conviction targets, and when hedging tools happen to be cheap amid downturns, buy a little."

Momentum Factor Collapse: The Cost of Concentrated Positions

The strong market in the first half of the year led to highly concentrated positions, which is the root of the recent pullback.

Goldman Sachs’ flagship momentum paired index (GSPRHIMO, momentum factor) has fallen 22% from its June high, with volatility surging to a five-year peak. This is not random market noise, but the result of position squeezes.

Pasquariello outlined several background factors behind the turbulence in momentum:

  • Positions are excessively concentrated: Goldman Sachs’ US portfolio strategy sentiment indicator currently reads 2.0 standard deviations, at the 98th percentile, the highest since December 2024.
  • Gains are too extreme: The Philadelphia Semiconductor Index (SOX) has more than doubled since the March 30 low, with leveraged semiconductor ETFs fueling the rally.
  • Explosion of speculative leverage: Trading volumes in US-listed leveraged ETFs are several times recent levels, "clearly felt in daily price movements."
  • Seasonal headwind: July has always been a "bad month" for momentum factors, usually due to the short side.

The result: The energy and technology sectors, which led gains in the first half, have suffered the greatest pullback pressures; meanwhile, previously lagging healthcare and financial sectors have recently started to climb.

AI Narrative Becomes More Complex: Q2 Earnings Are Key

Pasquariello believes that "the direction of AI capital expenditure is the most important single variable in today’s market," and Q2 earnings season will provide a major test.

He points out two core dimensions: First, the scale of forward-looking spending—which is "rocket fuel" for various AI infrastructure providers, but also increases financial pressure for hyperscale cloud companies; second, whether these cloud companies can prove their spending is flexible and even linked to revenue growth.

His judgment: "Given the quality of these management teams and the recent sharp reduction in positions, investors are too pessimistic about this group."

He also quoted his colleague Rich Privorotsky’s analysis, which has a concise description of the tension in the AI narrative:

Hyperscale cloud companies own infrastructure, software, distribution channels, and customer relationships. What they have is a toll road, not just a vehicle. Shifting to open-weight models and routing will bring more traffic to scale platforms and provide efficient outcomes for end customers. They only need to prove they can adjust spending and reach an inflection point on free cash flow.

In other words, cloud companies’ moat lies not in any particular model, but in the entire infrastructure chain. Pasquariello’s judgment is that, considering the quality of these management teams and the recent sharp reduction in positions, investors are "too pessimistic about this group."

The bigger question is: The S&P 500’s earnings growth has performed well for six consecutive quarters, but can it continue? The baseline forecast is still for double-digit growth in 2027. But given the uncertainty of the AI path and the constraints of the law of large numbers, "the risk of a hangover effect in 2028 is hard to ignore."

Small Caps: Tailwind Weakening

Small caps’ strong performance over the past year has attracted widespread attention, but Pasquariello cites Goldman Sachs analyst Ben Snider’s research, raising several cautious points about the outlook for the second half:

  • Macro backdrop turns unfavorable: "Into 2026, the combination of accelerating economy and Fed easing provided an ideal backdrop for small caps, but these macro dynamics appear less favorable in the second half."
  • AI tailwind weakens: After index rebalancing, AI infrastructure stocks’ weighting in the Russell 2000 fell from 15% pre-restructuring last Friday to 7% now.
  • Earnings expectations diverge: Since the start of the year, analysts have raised 2026 EPS expectations for the S&P 500 by 9%, but lowered Russell 2000 expectations by 9% in the same period.

Bull Market Not Over, But Path Is Bumpier

Pasquariello’s final judgment is:

"The continuation of the bull market is supported by the resilience of the US economy, strong earnings growth, and sustained household financial inflows. Nonetheless, internal market tension is intensifying—reflected in increasingly complex AI narratives and accumulation of speculative leverage."

His strategy advice has basically been unchanged for a month:

"The main trend remains upward, but the path in the coming months will be broader and bumpier. Therefore, my advice is: stay invested, but simplify the portfolio to highest conviction positions, and opportunistically buy downside protection tools when they are ‘on sale’."

Risk Disclosure and DisclaimerThe market contains risks; investment requires caution. This article does not constitute personal investment advice, nor does it take into account the specific investment goals, financial conditions, or needs of individual users. Users should consider whether any opinion, viewpoint, or conclusion in this article is suitable for their particular circumstances. Investing based on this article is at your own risk. ```