Goldman Sachs noted that beneath a calm surface, the US stock market experienced a dramatic shakeout in July, with the most crowded AI and momentum trades hit by a wave of deleveraging. The market's logic appears to be shifting from "hype narratives" back to "real returns." While the bull market hasn't ended, the era of effortless gains is over, and the path ahead is expected to be bumpier, with leverage no longer being forgiven.
The S&P 500 held its ground this week, with a monthly range of just 3.5% and trading less than 2% from its highs. Counter-intuitively, equal-weight S&P 500, low-volatility S&P 500, and the S&P 500 excluding AI stocks all hit new record highs. According to Goldman Sachs' head of hedge fund coverage, Tony Pasquariello, a "hammer came down on consensus positioning" over the past month, particularly after high-speed trades experienced a parabolic rally. He leans towards the view that the frenzy has subsided.
The key point is not that risk has disappeared, but that the most crowded and leveraged trades have been forced to cool down. This created a split between a calm index and turbulent underlying moves. While the S&P 500 had daily moves of less than 1% this week, Goldman's flagship momentum basket experienced nearly 10% daily swings. The Goldman TMT momentum basket, which was up 145% year-to-date on June 22nd, then suffered its worst drawdown on record before rebounding 17% in a single day. Similarly, Asian fundamental long/short equity funds, which had record performance in the first half, suffered their biggest monthly drawdown in a decade, while South Korea's KOSPI surged 18% overnight.
This framework leads to an uncomfortable conclusion: while the outlook for US stocks remains favorable, the risk/reward is no longer cheap, and the upside elasticity for global equities has weakened. The bull market isn't dead, but this is not a "buy and forget" phase.
The Index Survived, Crowded Trades Didn't
The biggest potential misread in July is to only look at the S&P 500, which hasn't given a panic signal. The index is less than 2% from its highs with a monthly range of only 3.5%, appearing as normal consolidation. However, active managers below the surface experienced a different market, as hot momentum, AI stocks, Korean equities, and Asian long/short strategies were all hit by forced deleveraging. The issue wasn't the size of any single day's decline, but the sudden loss of liquidity in the most profitable trades. Watching the S&P 500 offered a picture of stability; watching high-momentum tech stocks revealed near-uncontrollable volatility. This July split was crucial: the index level saw calm seas, but the positioning level saw ships capsizing.
This deleveraging was not a minor rebalance but a genuine washout. Global tech exposure saw its largest sell-off in over five years. The AUM of levered ETFs for Korean stocks plummeted from a June peak of $53 billion to $15 billion. Gross exposure reductions seen by Goldman's prime brokerage were the largest since the end of 2022. More granular data showed that the leverage exposure of fundamental long/short clients to the momentum factor has fallen to the 28th percentile of its one-year range. The crowded trade has gone from "everyone on board" to a significant portion being forced off.
This doesn't mean the painful trade can't return. However, compared to early July, there is significantly less chasing impulse and much more cash and discipline in the market.
The AI Trade's Conflict: From Narrative to Returns
In the latter half of July, the AI trade faced more than just profit-taking. It confronted a more fundamental question: can the massive AI capex by hyperscale cloud providers generate sufficiently clear and sustainable returns? Last week, market skepticism on this question increased. This week provided mixed answers, but better than the worst-case scenario. Meta hasn't proven significant AI returns are in hand. Microsoft gave a clearer signal that capex is converting into revenue and AI products at scale. Amazon followed with accelerating AWS growth and expanding cloud margins. Credit spreads for hyperscale cloud bonds also narrowed.
These changes are significant. If the AI trade only reflected "huge spending, distant returns," valuations would be under pressure. However, if some companies can show spending converting into revenue, the market won't treat the entire AI chain the same. Differentiation has emerged. The phase where simply adding an "AI" label could boost valuations is now much harder after this washout.
Fed Communication Gets Darker, Long-end Rates Become a Stock Problem
Equity traders were not reassured after the FOMC meeting. Volatility in the long end of the Treasury curve briefly spilled over into the stock market. More problematic is the change in communication style. The market, previously used to high transparency, is now entering a more restrained, less prescriptive phase. Traders have to gauge policy direction with fewer clues, which naturally creates friction. The key for stocks is to watch the policy direction, not every word. However, changes in long-term interest rates cannot be ignored, especially for long-duration stocks. AI, tech, and growth stocks are more sensitive to discount rates on far-dated cash flows. If the long end of global bond markets continues to exert pressure, "a stable base" doesn't mean "comfortable every day."
US Stocks Still Favorable, But Upside Elasticity Thins
From a larger framework, US stocks haven't lost their support. The economy is performing well, earnings growth is strong, fund flows are turning more positive, and nearly $1 trillion in AI capex is moving through the system. This explains why the S&P 500 held up during the underlying violent deleveraging. The index isn't without risk, but it has enough support factors to cushion the fall. However, this is not a signal for aggressive bullishness. The direction for US stocks is still favorable, the risk/reward is mid-range, and the upside elasticity for a continued major rally in global equities is less than in the prior phase.
More volatility is expected in the short term. Summer liquidity is poor for risk transfer, and when a position is crowded, illiquid, and structurally complex, volatility can be amplified. At the portfolio level, it's more suitable to increase liquidity and reduce complexity rather than continue chasing the steepest trades.
The Nasdaq's Answer: Bull Market Intact, Path Gets Harder
The Nasdaq 100 is currently 8% off its June highs but is still up 12% for the year. Over the past 9 months, it has fallen in 6 of them but is still up 9% point-to-point. Its P/E ratio has fallen back into the lower end of its multi-year range. This set of numbers clearly depicts the market state: the trend is not broken, but the process is painful. For trading, the destination and the path are not the same. The Nasdaq's primary bull market is still intact. However, if the future rhythm is "rally, flush out a position, then repair," making money will be harder than just being right on direction. July has served as a warning: the market does not reward crowding and does not forgive leverage.
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