While the broader market worries about a potential downturn, Goldman Sachs Prime Brokerage and Delta One desks are issuing a starkly different warning—the real danger may be a short squeeze triggered by forced short covering.
The latest data from Goldman Sachs Prime Brokerage and Delta One desks reveals that the market's primary potential driver is not fundamentals, but rather extreme positioning: short positions in US macro products (indices and ETFs) have surged to their highest level in a decade. Meanwhile, nearly 25% of the top 100 S&P 500 constituents exhibit an inverted call skew—a pattern reminiscent of the 2021 meme-stock short squeeze frenzy.
The S&P 500 rose 0.9% last week, marking its eighth consecutive weekly gain. Despite facing headwinds such as a post-earnings sell-off in Nvidia following its strong results and weak economic data (including a record-low University of Michigan Consumer Sentiment Index), US equities demonstrated remarkable upward momentum.
Beyond this, data from Goldman Sachs' trading desks uncovers even more striking structural tensions beneath the surface. Earlier this month, single-day notional trading volume in S&P 500 (SPX) call options reached a staggering $2.6 trillion, representing approximately 4% of the index's market capitalization. Hedge fund gross leverage in US equities saw its largest weekly increase in over three years, while net exposure to technology stocks (as a percentage of the prime broker book) hit a five-year high, placing it in the 100th percentile. The consumer staples sector experienced its largest net selling in over five years, whereas consumer discretionary, after being sold in nine of the past ten weeks, saw its fastest pace of net buying in over two months.
Goldman Sachs' trading desks argue that the core market conflict is not the state of fundamentals, but the risk of a self-reinforcing upward spiral should the over-accumulated short positions trigger a wave of covering.
**Hedge Fund Activity: Gross Leverage Hits 3-Year High, Extreme Divergence in Tech and Consumer Sectors**
Goldman Sachs Prime Brokerage data shows the US equity market overall saw moderate net buying last week, with single-stock long buys outpacing short sells (at a ratio of 1.2 to 1). Notably, gross leverage for US long-short strategies recorded its largest weekly increase in over three years, with total trading activity rising across all sectors.
**Tech Stocks Regain Favor:** Despite hedge funds selling US information technology stocks over the past month, they abruptly reversed course last week, net buying the sector at the fastest pace since mid-March. Both total and net exposure to the information technology sector (as a percentage of the total US prime broker book) reached five-year highs, residing at the 100th percentile historically.
**Sharp Divergence in Consumer Sectors:** Consumer discretionary, sold in nine of the past ten weeks, experienced its fastest net buying in over two months last week (driven entirely by long buys). Conversely, consumer staples became the most net-sold sector, with fund managers aggressively shorting it, setting a record for the largest net selling in over five years.
**ETF Short Covering:** Macro products (indices and ETFs) saw slight net buying. While investors had favored shorting ETFs over single stocks due to squeeze fears, short positions in US-listed ETFs declined by 4% last week for the first time in three weeks, primarily driven by covering in large-cap and tech ETFs.
**Macro and Flows: Index-Level 'Squeeze' Risk is Real, Macro Shorts at 10-Year High**
Goldman Sachs' Delta One desks note that the S&P 500 moved higher heading into the long weekend despite Middle East geopolitical headlines, sharp volatility in momentum factors, and mixed consumer data.
**Mixed Consumer Signals:** Retail long targets like Ross Stores (ROST) and AS performed well. However, data from bellwethers like Walmart (WMT) and Target (TGT), while not poor, fell short of elevated market expectations. Walmart's 7% drop on its earnings day, its largest single-day decline in three years, fueled concerns about consumer weakness. Additionally, the final May University of Michigan Consumer Sentiment Index hit a record low, pressured by high oil prices and interest rates.
**Flows Normalizing:** Asset managers and hedge funds ultimately acted as moderate net buyers. While steady inflows into the semiconductor/AI space continued, the "frenzied" buying seen in early April has significantly subsided.
Goldman Sachs' Delta One desks believe the risk of an index-level short squeeze is tangible. Short exposure to US macro products (indices + ETFs) on Goldman's books has risen above pre-Iran ceasefire levels to a 10-year high. Goldman attributes this to investor nervousness over macro factors (Iran/rates/oil) coupled with a reluctance to use single-stock shorts as a hedge.
**Derivatives Market: Call Option Frenzy, Inverted Skew Echoes 2021 Patterns**
Frenzied activity in upside options is a defining theme in the derivatives market. Earlier this month, single-day notional trading volume in S&P 500 (SPX) call options hit $2.6 trillion (roughly 4% of the index's market cap).
Further highlighting the broad market squeeze risk, the latest data from the Chicago Board Options Exchange (CBOE) shows that nearly 25% of the top 100 S&P 500 constituents exhibit an inverted call skew—a phenomenon identical to the skew characteristics observed during the 2021 meme-stock short squeeze.
Currently, the market segments with the highest concentration of bullish call option positioning are also where sentiment is most euphoric.
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