US equities have been on a sustained rally since late March, giving investors numerous reasons for concern about the market's future trajectory. However, from the perspective of Goldman Sachs traders, extreme positioning crowding is not the primary worry.
A Goldman Sachs metric that gauges overall market sentiment is currently hovering around 0.2, signaling that risk exposure is at a neutral level. This indicator tracks the US equity risk exposure of institutional, retail, and foreign investors, covering approximately 80% of the US stock market's capitalization. Goldman Sachs traders, including Tom Shea, wrote in a client note that the indicator "suggests the rally has yet to be fully embraced by market participants."
Prior to the sharp decline on Friday, US stocks were on track to achieve their longest weekly winning streak since 1985, with market exuberance building. Yet, data indicates the market has not shown the kind of overheating signs that typically leave no room for error. For investors who witnessed Friday's sell-off, this can be seen as a piece of positive news.
"If we don't see investors piling in aggressively during the rally, then it's less likely we'll see a mad dash for the exits if sentiment deteriorates," said Dave Mazza, CEO of Roundhill Financial Inc. "This rally may not be as frothy as it appears on the surface."
There could be several reasons why equity positioning is not overly crowded. In Mazza's view, large funds may be cautious about chasing the rally further, given that the market has already risen 16% since late March.
Max Gokhman of Franklin Templeton points out an imbalance in hedge fund positioning, with substantial exposure to AI-related stocks and relatively less allocation to other sectors. Data compiled by Goldman Sachs shows that hedge funds' net leverage, which includes long positions minus short positions, is at its highest level in a year.
"Hedge funds are leaping over the wall of worry with leverage, while institutional investors are watching from the sidelines, waiting to see how the more exuberant investors land," Gokhman said.
Market sentiment reversed on Friday amid signs of minimal progress in US-Iran peace talks. Additionally, the worsening sentiment was exacerbated by the S&P 500 index's refusal to provide a fast-track for inclusion of mega-IPO companies like SpaceX.
Before this, the S&P 500 had risen 0.4% on Thursday and was poised for its tenth consecutive weekly gain. The last time such a prolonged winning streak occurred was during the Reagan administration in 1985. Earlier in history, this phenomenon has only happened twice, in 1957 and 1943.
Although indicators like positioning crowding suggest this rally has not reached overheated levels, the market has clearly exhibited a sense of excitement. In the options market, demand for protective strategies has nearly vanished. Investors seem more concerned about missing out on further gains than about hedging against a downturn.
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