As geopolitical tensions continue to escalate, Wall Street's optimistic expectations for a "quick resolution" are rapidly unraveling. On Friday, Shawn Tuteja, a top trader at Goldman Sachs, highlighted in a recent client report that the market narrative is undergoing a critical shift—from a firm belief in a swift end to the conflict towards pricing in "indefinitely extended uncertainty."
Tuteja noted that over the past several weeks, the predominant view among Goldman Sachs clients was that the geopolitical conflict would be "resolved." However, as the situation persists, this confidence is wavering. A sharp turn in sentiment occurred last weekend, with clients initiating substantial short positions on low-quality equity portfolios and European assets, while simultaneously betting on persistently rising oil prices. Concurrently, the Federal Reserve's relatively hawkish stance on Wednesday further dampened risk appetite. Clients widely felt that the Fed missed an opportunity to soothe the market, instead choosing to emphasize economic strength, thereby exacerbating bearish sentiment.
The S&P 500 is currently down approximately 5% from its historical peak and is essentially flat compared to six months ago. Tuteja believes the risk-reward profile has become more symmetrical than before but cautions that a downturn in the AI sector or momentum long positions could expose the market to tail risks for which clients remain under-hedged.
**Narrative Shift: From "Quick Fix" to "Intractable"**
Tuteja pointed out that in recent client discussions, the consensus overwhelmingly favored the idea that the conflict "will be resolved," even if the specific path to resolution remained vague. However, the credibility of this narrative is eroding as the situation drags on. Last weekend marked a clear inflection point. Clients began fearing that oil supplies could face shortages within weeks, with a timely solution appearing unlikely. This expectation drove large-scale shorting of low-quality equity baskets—including the Russell 2000 Index (RTY) and the Goldman Sachs Low Quality Stock Basket (GSXULOWQ)—along with new short positions on European assets.
Entering this week, however, market movements proved uncomfortable for bears as well—equities rebounded without clear signals of resolution, leaving fast-money clients who had adjusted their positions caught on the wrong side. Tuteja described the first four trading days of the week as characterized by two-way flows and clearly divided sentiment. Currently, the client base is split between two starkly different outlooks: first, a resolution within one to two weeks; second, a stalemate where the market adjusts either through a sharp, leverage-driven sell-off or a prolonged, slow decline akin to 2022. The latter, more pessimistic scenarios are being expressed through derivatives like VIX call options, S&P 500 tail-risk put options, and VKO.
Amid the uncertainty, capital is seeking safety cushions. Communications with Goldman Sachs clients indicate that the median consensus for a "blind buy" level on the S&P 500 is between 6100 and 6200, suggesting a potential 6% to 7% downside from current levels.
**Fed's Hawkish Stance Amplifies Market Fragility**
The Federal Reserve's commentary on Wednesday introduced additional pressure. Tuteja noted that clients generally believed the Fed had an opportunity to offer reassuring signals amid current turbulence but instead chose to highlight economic strength, a stance interpreted as hawkish, further suppressing risk sentiment. Against this backdrop, movements in the rates market are particularly noteworthy. Earlier this year, yields rose alongside the outperformance of cyclical stocks versus defensives, reflecting expectations of an economic re-acceleration. Recently, however, this correlation has broken down significantly—despite cyclical stocks substantially underperforming defensives, the market is now pricing in a higher terminal rate and scaling back rate cut expectations.
Tuteja views this "dramatic volatility in the bond market," occurring amidst weak non-farm payrolls data and growing skepticism around the AI narrative, as a concentrated manifestation of fragility across asset positioning. He suggests the rapid shifts in the rates market are likely driven by positioning changes rather than a fundamental shift in economic outlook.
**AI Narrative Remains a Pillar, But Poses Potential Tail Risk**
Despite market turbulence, the AI narrative remains intact. Data from Goldman Sachs's proprietary book shows that positioning in AI-related themes is at historically high levels, and holdings in the "Mag 7" are near record highs—as doubts about growth prospects emerge, capital has reconcentrated in these names. On a relative performance basis, the ratio of the Goldman Sachs AI Long Basket (GSTMTAIP) to the S&P 500 ex-AI Index (SPXXAI) is near its historical peak, with each subsequent pullback becoming increasingly shallow.
However, Tuteja identifies this highly concentrated AI positioning as a potential risk. He suggests that signs of broad market capitulation would likely first appear in the AI sector—a stage clearly not yet reached, implying clients are inadequately prepared for downside risks related to AI and momentum longs. Data from Goldman's proprietary book also shows overall client exposure to the momentum factor at a five-year high. Tuteja recommends optimal tail-risk hedging through put spreads on GSTMTAIP and the Goldman Sachs Medium-Term Momentum Factor Long Basket (GSX1BFML)—a two-month 80/95% put spread on the former costs approximately 2.62%, while a similar 75/90% put spread on the latter costs about 2.67%.
**Valuation Contraction Underway, Risk-Reward Becoming More Symmetrical**
From a broader perspective, the S&P 500 has been essentially flat since mid-September last year, showing zero returns over roughly six months. Goldman Sachs Research maintains its 2026 EPS forecast of $309 and 2027 forecast of $342, believing that the impact of lower GDP growth projections will be offset by increased AI-related investment expenditure. Tuteja notes that with earnings expectations being revised upwards, the index's stagnation over six months essentially signifies a contraction in valuation multiples. Although U.S. equity valuations at the start of the year were expensive by historical standards, the compression in the Next-Twelve-Months (NTM) P/E ratio over the past six months is significant within the context of the last 45 years of data.
In this context, Tuteja believes the current risk-reward profile is more symmetrical than before. He observes that when the index was at higher levels, the market debated "how much a ceasefire announcement could boost prices"; at current levels, the potential upside has become more substantive. He concludes that, on a net positioning basis, clients are somewhat hedged against a minor equity market decline and are therefore not inclined to be overly bearish at current levels. However, he emphasizes that client preparedness for a sell-off driven by weakness in AI or momentum longs is clearly insufficient, representing the most significant tail risk in the current market environment.
Comments