As the S&P 500 notched its eighth consecutive weekly gain, Goldman Sachs has identified increasingly pronounced signs of a potential short squeeze in the market. The report notes that the ongoing accumulation of short positions alongside rising demand for call options is providing technical support for further gains in U.S. stocks, but it also signifies a deepening market reliance on such momentum-driven flows.
Data from Goldman Sachs' prime brokerage shows that short positions in U.S. macro products (indices and ETFs) have climbed to their highest level in the past decade. Faced with uncertainties surrounding geopolitics, interest rates, and oil prices, many investors are opting to build hedges through indices and ETFs while avoiding direct short positions in individual stocks. However, should the market continue its ascent, these short sellers may be forced to cover their positions, creating additional buying pressure and further propelling stock prices.
The options market is sending similar signals. Goldman Sachs derivatives trader Brian Garrett pointed out that approximately 25% of S&P 100 component stocks are now exhibiting inverted call skew, a level nearing that seen during the 2021 "meme stock" short squeeze episode. In his view, the market is displaying clear characteristics of "upside optionality," with investors increasingly placing bets on further gains. Market makers, in turn, must continuously buy stocks to hedge their related risks, further amplifying the upward momentum.
Goldman Sachs views this as both a market support factor and a potential vulnerability—the current rally is being driven, in part, by short covering and options-related flows rather than solely by fundamental improvements. Should these technical sources of buying diminish, market volatility could subsequently increase.
U.S. Stock Fund Flows Recover: Tech Stocks See Renewed Buying, AI Semiconductors Remain in Focus
Data from Goldman Sachs' prime brokerage indicates that U.S. equities overall recorded slight net buying last week, with the scale of long-side purchases being about 1.2 times that of short covering. Concurrently, the total leverage ratio for U.S. long/short funds posted its largest single-week increase in over three years, and trading activity across sectors generally recovered.
Breaking it down by sector, the individual stock sector has now seen net capital inflows for three consecutive weeks. Information Technology, Consumer Discretionary, and Real Estate were the most favored sectors, while Consumer Staples, Materials, and Energy experienced net outflows. Notably, both the gross and net exposure for the Information Technology sector have risen to their highest levels in nearly five years, placing them at the 100th historical percentile.
After a month of reducing exposure to U.S. tech stocks, hedge funds pivoted notably last week, adding to the Information Technology sector at the fastest pace since mid-March. Goldman Sachs' Delta One trading desk noted that flows are still primarily directed towards semiconductors and AI-related areas. However, compared to the "frenzied chasing" seen in early April, market sentiment has now clearly become more rational.
Divergence Within the Consumer Sector: Discretionary Sees Covering, Staples Faces Exodus
However, within the consumer sector, capital flows have shown a marked divergence.
After reducing exposure to the Consumer Discretionary sector in nine of the past ten weeks, hedge funds engaged in significant covering last week, net buying the sector at the fastest pace in over two months. Nearly all sub-sectors, except for Automobiles, saw inflows, with Broadline Retail, Textiles, Apparel & Luxury Goods, Hotels, Restaurants & Leisure, and Consumer Durables being the most favored.
In stark contrast, the Consumer Staples sector faced concentrated outflows, becoming the sector with the largest net selling for the week and setting a record for the highest net selling in over five years. Fund managers widely adopted aggressive shorting strategies, with the Consumer Staples Distribution & Retail sub-sector bearing the brunt.
This divergence reflects the market's complex assessment of the U.S. consumption outlook. On one hand, capital is beginning to bet on an improvement in discretionary demand. On the other hand, the fundamental backdrop for consumption remains under pressure. Walmart's stock plunged 7% in a single day following its earnings report, marking its largest drop in three years. Meanwhile, the final May reading for the University of Michigan Consumer Sentiment Index fell to a historic low, with elevated oil prices and interest rates continuing to weigh on consumer willingness to spend. Goldman Sachs' Delta One trading desk noted that despite recent signs of covering, the consumer sector as a whole remains one of the market's least favored areas.
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