As momentum trading experiences its largest consecutive pullback since 2022, the market's highly concentrated bets on the AI theme are undergoing a reassessment. Louis Miller, head of Goldman Sachs' global custom stock basket business, believes investors are showing a stronger willingness to diversify, and the outline of "post-conflict trades" is gradually coming into focus.
The two-and-a-half-day momentum sell-off initiated around last Friday marks a phased shift in market sentiment. Miller points out that beyond core AI assets, oversold consumer sectors, overlooked healthcare, and financial and defense sectors benefiting from the interest rate environment and geopolitical easing are becoming new focal points for capital.
Simultaneously, the persistence of a high-interest-rate environment is also creating new risk exposures. Miller warns that if U.S. Treasury yields cannot retreat to "pre-conflict" levels, low-quality stock baskets face over 20% relative downside potential, and the vulnerability of non-profitable tech stocks should not be overlooked either.
Momentum Trading Takes a Hit, Diversification Window Opens According to data from Goldman Sachs' FICC and Equities division, the momentum pullback initiated last Friday is the largest consecutive momentum decline since 2022. Miller characterizes this as a signal of investors' "increasing willingness to diversify," rather than a mere technical adjustment.
Throughout the "wartime" phase, Goldman Sachs' Bottleneck Basket has been the preferred alternative direction outside of core AI assets. Miller states that the market's definition of AI is expanding from semiconductors and hyperscale cloud providers to broader fields, and investors are also beginning to seek AI exposure outside the United States.
Asian AI trades have performed strongly this year, but last week's momentum sell-off created rare buy-the-dip opportunities in some themes. Goldman Sachs' Asia AI Bottleneck Basket corrected by approximately 3% over the past week. Miller believes this basket, focusing on the most supply-constrained and pricing-power-strong segments of AI infrastructure, holds significant allocation value.
Low-Quality Stock Risks Highlighted in High-Rate Environment Miller clearly indicates that if interest rates remain elevated for an extended period, certain expensive sectors will face significant pressure. Goldman Sachs' Low Quality Stock Basket integrates multiple thematic baskets with low-quality characteristics, covering non-profitable tech stocks, low-margin small-cap stocks, and companies sensitive to high-yield debt.
Data shows that despite the substantial rise in the U.S. 10-year Treasury yield, the performance of the Low Quality Stock Basket has been relatively resilient. However, Miller warns that if yields cannot fall back to pre-conflict levels, this basket has over 20% relative downside potential.
Regarding the choice of interest-rate-sensitive hedging tools, Goldman Sachs' Non-Profitable Tech Basket has been one of the most popular options. However, Miller prefers the newly launched Non-Profitable Non-Tech Basket. This basket excludes names heavily driven by market sentiment, such as space, satellite, and quantum computing, making it a more precise interest-rate-sensitive short.
Healthcare: A Compounding Asset with Low Correlation to AI The healthcare sector has long underperformed cyclical stocks, lacks major catalysts, and has faded from market focus. But Miller views this sector as a compounding asset negatively correlated with AI trends—performing steadily during AI sell-offs while also being a beneficiary of AI applications.
Goldman Sachs data shows that the excess correlation between various U.S. healthcare subsectors and AI is generally negative. Specifically, Miller is optimistic about the biotech sector, citing the upcoming pharmaceutical patent cliff as a driver for M&A activity, making Goldman Sachs' Biotech Strategic M&A Basket attractive in this context. The life science tools sector is expected to benefit from end-market recovery, while growth in biologics will drive the entire pharmaceutical supply chain upward.
Financial Stocks Outside the U.S.: Dual Beneficiaries of Rates and Post-Conflict Cycle Miller states that interest-rate-sensitive financial stocks will benefit from both the high-interest-rate environment and the cyclical recovery post-conflict. Although U.S. financial stocks may perform well in the short term, considering the uncertainty surrounding the mid-term elections this year, he currently prefers financial exposure outside the United States.
In Europe, Goldman Sachs' High Net Interest Income Basket focuses on banks with the most profitable leverage to interest rates. The Greek Bank Basket also meets the high net interest income criteria and additionally possesses robust loan growth and valuation advantages relative to European peers.
In Asia, the Japan Bank Trade has allocation logic ahead of next month's Bank of Japan meeting, with the latest BOJ stance leaning towards continued rate hikes.
European Defense: A Return Opportunity After Valuation Reset Global defense spending continues to rise, with the Eurosatory defense exhibition in June and the NATO summit in July bringing a series of catalysts. Miller notes that after significant valuation compression and position unwinding since the start of the year, the European Defense Trade is making a comeback. There remains at least a 10% gap for recovery between its year-to-date price performance and earnings per share revisions.
From a valuation perspective, if the European defense sector returns to its median valuation multiples from last year, it implies over 20% upside potential. Miller also points out that while the market generally perceives European defense as lagging behind the U.S. and Asia in high-tech content, exposure to a purer "new defense" theme can be gained in the small and mid-cap space.
The U.S. Defense Trade valuation has also declined. The previous sell-off was primarily beta-driven, while post-conflict inventory replenishment is expected to bring earnings upgrade expectations.
Three "Post-Conflict Scenario" Trades: Option Structures to Capture Binary Inflection Points Miller has also designed three specific trades for "post-conflict" scenarios.
First, the Low Momentum Squeeze Trade. Currently, U.S. momentum is highly synonymous with AI trades. If substantial downgrade catalysts emerge, the Low Momentum Basket could face a short squeeze. For the consumer sector, Miller suggests expressing upside exposure through options.
Second, the Gold vs. Oil Binary Binary Option. In a post-conflict scenario, gold miners and buyers are naturally short oil, and potential sovereign wealth fund custody arrangements could pressure the U.S. dollar.
Third, the Equity-Bond Dual Hedge. Miller notes that waning AI enthusiasm could drag down the broader market, as AI contributed approximately 6 percentage points of the S&P 500's return over the past six months. Goldman Sachs' Volatility Structuring team believes that the end of the conflict combined with cooling AI enthusiasm could lead to a scenario of a 3% drop in the S&P 500 and a 30 basis point decline in the 10-year yield. Miller also specifically notes that the current market focus is on inflation risk, meaning the cost of hedging growth risk is relatively low.
Comments