U.S. stock markets are getting tense! Goldman Sachs: Continue to be bullish on AI, but hedge—low-quality sectors have already detached from fundamentals.

The strong rally in AI-themed stocks and excessive positioning have raised clear concerns in the market about the potential for a pullback.

Goldman Sachs stock basket trading head Louis Miller stated in a recent research report that Goldman’s trading desk remains bullish on AI themes, but “we are entering a phase with relatively scarce catalysts, and it’s necessary to protect year-to-date gains.” He pointed out that the current market shows structural differentiation: The fundamentals of the AI sector are solid, and investors should maintain long positions and deploy short-term hedges; low-quality stocks are significantly detached from their fundamentals and can be shorted opportunistically.

Miller emphasized that the rise in the AI sector is supported by strong earnings revision data, and its fundamentals remain robust. In contrast, the broader market rally has caused valuations of low-quality sectors to diverge sharply from their fundamentals, creating attractive shorting opportunities.

It is worth noting that momentum in Asian markets has already shown a clear pullback, coupled with ongoing increases in global long-term interest rates, rising inflation pressures, and rapidly climbing leverage levels, sending warning signals from the bond market. For investors, current position management and risk hedging strategies have become more urgent issues than directional judgments.

AI theme remains strong, but crowded positions trigger defensive needs

Looking back at recent markets, the AI sector has significantly outperformed other areas. Miller pointed out that Goldman’s US AI data center basket (GSTMTDAT) has outperformed the low-income discretionary consumer basket (GSXULOWD) by nearly 100 percentage points since the start of the year, with excess returns of about 20 percentage points over the past two weeks. Top long-term growth themes have doubled in value this year, while cyclical and fragile sectors have lagged noticeably.

Currently, despite short-term volatility, the resilience of the AI rally remains evident. The high-beta momentum portfolio (GSPRHIMO), though once experiencing a 5% single-day decline, still posted about a 3% positive return overall this week. However, Miller cautioned that AI-related trades have historically experienced phased declines multiple times, and we are now in a catalyst-scarce window, providing a reasonable basis for short-term protective measures.

Regarding hedging tools, a one-month AI broad-based put option basket with a strike price of 93% (GSTMTAIP) costs about 1.70% (covering 22 trading days); for the momentum loss portfolio (GSXULMOM), a bullish spread protection collar costs about 0.7%. Both are cost-effective risk management tools in the current environment.

Energy security becomes the most favored theme outside AI

Among non-AI themes, Miller pointed out that energy security has been identified by Goldman Sachs as the most conviction-driven investment theme globally at present.

In the US market, the domestic solar basket (GSXUSOLR) has emerged from the broader power theme (GSX1POW1), showing an independent upward trend. Miller believes that as midterm elections approach, market focus on power supply and electricity prices will persist, and the earnings outlook for GSXUSOLR supports further extension of this rally.

Across the Atlantic, the European market also offers opportunities in the power theme, but with a very different logic. Global capital interest in the region has once again waned, but this “low crowding” creates structural opportunities. Goldman Sachs has doubled down on European power themes (GSXEPOWR)—the earnings revision breadth of this basket is currently at its highest in history and is unaffected by US midterm elections.

Consumer sector: crowded short positions, short-term performance unlikely to change macro prudence

In the consumer sector, Miller advises against further increasing short positions. Several sub-sectors, including low-income discretionary consumer (GSXULOWD) and middle-income discretionary consumer (GSXUMIDC), have underperformed the S&P 500 by 10 to 15 percentage points since the start of the year. Given that short positions are already quite crowded, further adding to shorts could face short-term “short squeeze” risks.

Goldman Sachs consumer industry expert Scott Feiler noted that some consumer companies (including ONON, BIRK, ARMK, YETI, etc.) have reported decent earnings this week, and most representative stocks are expected to beat expectations, with little pressure on guidance.

However, Miller from a macro perspective warns against over-optimism due to short-term good performance. “Stagflationary pressures eroding consumers’ wallets remain a core fundamental judgment,” he said, “and one should remain calm in the face of any sharp rallies.”

Risk warning and disclaimer

        The market carries risks; investment should be cautious. This article does not constitute personal investment advice and does not consider individual users’ specific investment goals, financial situations, or needs. Users should consider whether any opinions, views, or conclusions herein are suitable for their particular circumstances. Invest accordingly at their own risk.