The major U.S. stock indices remain near their highs, but the internal trading structure of the market has become more crowded and bumpy.
"The market's characteristics have clearly changed," observed Tony Pasquariello, head of Goldman Sachs' hedge fund business, in his latest market commentary on July 8. He noted that since hitting a peak in early June, the S&P 500 has been moving sideways within a volatile range. As the Q2 earnings season progresses alongside typical summer liquidity contraction, this choppiness is expected to persist and the path forward is likely to become even rougher.
His advice is that while the primary bullish trend remains intact, the path will be "wider and bumpier"—"stay in the saddle, but simplify your portfolio and concentrate on your highest-conviction ideas, and buy some downside protection when those tools are occasionally cheap."
Momentum Factor Breakdown: The Cost of Concentrated Positions
The strong market performance in the first half fostered highly concentrated positioning, which is now the root cause of the recent pullback.
Goldman's flagship momentum pair index (GSPRHIMO) has fallen 22% from its June peak, with realized volatility soaring to a five-year high. This is not random market noise but the result of a positioning squeeze.
Pasquariello outlined several background factors for this turbulence in momentum:
Excessively concentrated positioning: The latest reading of Goldman's U.S. portfolio strategy sentiment indicator is at 2.0 standard deviations, placing it in the 98th percentile and at its highest level since December 2024.
Extreme price appreciation: The Philadelphia Semiconductor Index (SOX) has more than doubled from its March 30 low, with leveraged semiconductor ETFs adding fuel to the move.
A surge in speculative leverage: Trading volumes for U.S.-listed leveraged ETFs are multiples of recent-year levels, "clearly felt in daily price moves."
Seasonal headwinds: July has historically been a "poor month" for the momentum factor, with issues typically arising from the short side.
The result is that the energy and technology sectors, which led the gains in the first half, are now under the most pressure from the drawdown, while previously lagging sectors like healthcare and financials have recently begun to move higher.
AI Narrative's Growing Complexity: Q2 Earnings Are Key
Pasquariello believes that "the direction of AI capital expenditures is the single most important variable in the market right now," and the Q2 earnings season will provide a major test for this thesis.
He highlighted two core dimensions: first, the scale of forward-looking spending—which acts as "rocket fuel" for various AI infrastructure suppliers but also intensifies financial pressure on the hyperscale cloud providers; and second, whether these cloud providers can demonstrate that their spending is flexible and can even be linked to revenue growth.
His assessment is: "Given the quality of these management teams and the significant derisking in positioning recently, investors are too bearish on this group."
He also referenced analysis from his colleague Rich Privorotsky, who offered a concise take on the tension within the AI narrative: Hyperscalers own the infrastructure, software, distribution, and customer relationships. They own the toll road, not just a car. A shift towards open-weight models and routing brings more traffic to scale platforms and delivers efficient outcomes for end customers. They just need to prove they can modulate spending and drive an inflection in free cash flow.
In other words, the cloud providers' moat lies not in any specific model but in the entire infrastructure chain. Pasquariello's judgment is that, considering the quality of management and the significant recent reduction in positioning, investors are being "too pessimistic" about this group.
A larger question remains: can the S&P 500's excellent earnings growth over the past six quarters continue? The baseline forecast still calls for double-digit growth in 2027. However, given the uncertainty around the AI path and the constraints of the law of large numbers, "it's hard not to think about the risk of a hangover effect in 2028."
Small-Cap Stocks: Favorable Tailwinds Are Fading
The strong performance of small-cap stocks over the past year has garnered widespread attention, but Pasquariello, citing research from Goldman analyst Ben Snider, offered several points of caution for the second half:
The macro backdrop is turning less favorable: "Heading into 2026, the combination of economic acceleration and Fed easing provided an ideal backdrop for small caps, but these macro dynamics look less supportive in the second half."
The AI tailwind is diminishing: Following the index rebalancing, the weight of AI infrastructure stocks in the Russell 2000 has dropped to 7% from 15% prior to last Friday's reconstitution.
Diverging earnings expectations: So far this year, analysts have raised 2026 EPS estimates for the S&P 500 by 9%, while simultaneously lowering estimates for the Russell 2000 by 9%.
Bull Market Not Over, But Path Is Rougher
Pasquariello's final assessment is: "The case for the bull market's continuation rests on U.S. economic resilience, excellent earnings growth, and continued household liquidity support. But simultaneously, tensions within the market are rising—manifested in a more complex AI narrative and the build-up of speculative leverage."
His strategic advice has remained largely unchanged for a month: "The primary trend is still higher, but the path over the next few months will be wider and bumpier. Therefore, my advice is: stay invested, but simplify the portfolio down to your highest-conviction positions and opportunistically buy downside protection when it is occasionally 'on sale.'"
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