Global stock markets are rising, can we relax? Goldman Sachs' top traders say it's not time to go all-in yet, save some ammunition for after the election

This Friday, global stock markets overall saw a rise: A-shares were all in the red, with the Shanghai Composite Index up nearly 3% and the ChiNext Index up nearly 8%. The two major U.S. stock indexes, the S&P 500 and the Dow Jones Industrial Average, are poised to set new closing record highs. After warning last week to "stay vigilant in the noise of the next month," Goldman Sachs' top trader and hedge fund research director Tony Pasquariello warned investors again that it's not time to go all-in yet, implying that there is still some "ammunition" in risk assets to be used after the U.S. election.

Pasquariello summarized the current trading environment in his report this Friday:

• As U.S. stocks continue to rise, the S&P 500 has risen for six consecutive weeks as of this week, marking the longest winning streak since the end of last year. It is worth mentioning that since October last year, the S&P has risen by 1725 points, a 42% increase.
• This week, as the trend progresses, we have seen some recent tensions easing: oil prices falling, implied volatility easing.
• More precisely, the S&P 500 has experienced both gains and pullbacks this week, resembling more of a seesaw than a straight freight train, but fund flows clearly continue to provide support. In this regard, Pasquariello reiterated that this is both a bull market and a trader's market.
• Discretion remains a bright and dazzling theme, with a lot of action behind the scenes. According to Pasquariello, the most interesting trend recently is the performance of cyclical stocks relative to defensive stocks (see code GSPUCYDE).
• Despite many smart people not thinking so, Pasquariello still believes that the performance of U.S. consumers will counter the bearish arguments (retail sales and the performance of U.S. banks have proven this).
• Outside the U.S. market, some skepticism has crept into the narrative of trading in the Chinese stock market; European stocks are still lagging behind U.S. stocks, as some very notable companies have earnings below expectations, significantly impacting the pan-European Stoxx 600 index (the only impressive exception being the power sector, see code GSXEPOWR).
• The performance of gold remains very strong, with the price of gold breaking $2700 this week. Pasquariello calls gold an asset that can meet any expectation, and he certainly doesn't want to provoke a dispute on potential demand stories.
• In stark contrast, if oil cannot maintain buying interest in the current geopolitical environment, or if it cannot maintain buying interest against the backdrop of the re-inflation theme in the U.S., the market will show its cards.
• The U.S. dollar has been in danger this month, but broader financial environment indices have not tightened, which is a good thing.

Pasquariello mentioned that some factors he is particularly concerned about have recently made the following progress:

1. China

This week, he observed two main issues: how the news flow is and how the fund flow is. Regarding the former: policy comments continue to be stable, with an overall positive tone, but have not brought about significant incremental impact. Regarding the latter, Pasquariello believes that Goldman Sachs' franchise fund flows tend to lean towards moderate profit-taking, as the speculative community continues to reduce trading lengths In short, some doubts have quietly crept into the market narrative, partly due to risk considerations before the US election. Following the press conference by the Chinese Ministry of Finance last weekend, Goldman Sachs raised its GDP expectations for 2024 and 2025, and the People's Bank of China began using swap facilities to support the capital market this Friday.

Combining the above findings, Pasquariello expects market turbulence leading up to the US election on November 5th, with all bets possibly being canceled thereafter. Therefore, he believes this should still be a tradable rebound, but he will exercise control, suggesting that options trading should be done in a form with limited losses.

2. Fund Flows/Positions

In a recent proprietary trading activity at Goldman Sachs, one thing that impressed Pasquariello was the report from Goldman Sachs Prime Brokerage (PB) stating that the selling momentum in US stocks for eight consecutive weeks ended last week, with buying interest continuing this week (through macro products).

Furthermore, some key market participants—namely systematic investment firms and US corporations—are currently on the sidelines. Therefore, along with independent hedge funds, US retail funds have been arbiters of price action (and are expected to continue bidding post-election unless there is a shock).

An additional perspective: If there is a rebound on the current basis, given the current gamma dynamics of S&P options, market makers should chase higher prices. In conclusion, under otherwise similar conditions, the story of fund flows still leans towards the long side.

3. Major Rotation—Or Not

From a more macro perspective, Goldman Sachs' US investment portfolio strategy team conducted some research on the prospect of $9.5 billion of money market assets entering the stock market. Their conclusion is: do not be nervous, as historical experiences from the eight Fed rate cut cycles since 1984 indicate that the Fed's easing cycles typically lead to capital inflows into the money markets, rather than outflows.

Additionally, Pasquariello points out that US households' allocation of funds to cash is currently at a historical low of 15%.

Pasquariello says, if these readings seem a bit too negative for US stocks, do not despair, as Goldman Sachs expects corporate stock buybacks to reach $1 trillion this year and next.

4. Earnings Reports

Last week, banks like JPMorgan Chase set a strong tone for the earnings season, but this week's tone appears more mixed, with 47% of listed companies exceeding one or more standard deviations, consistent with the long-term average but below recent trends.

In a series of earnings reports next week, Pasquariello believes that, relative to their respective sectors, blue-chip tech stocks have slightly lower earnings thresholds for the third quarter compared to the first and second quarters of this year. Part of the reason is reduced positions, which is evident in Goldman Sachs PB data, and part of the reason is the formal lowering of profit expectations.

Citing Goldman Sachs' US stock portfolio strategy strategist Ben Snider, Pasquariello comments that consensus data from analysts show lower thresholds for the third quarter, with an expected year-on-year increase of around 40% in earnings per share (EPS) for blue-chip tech stocks In the second quarter, the growth expectation is about 30%, while in the third quarter it is about 20%.

5. US Technology Stocks

When it comes to technology stocks, there was some tug-of-war again this week. Pasquariello admitted that compared to small-cap stocks, technology stocks did not perform well this week.

On Monday, leading technology stock NVIDIA closed at a historic high, but later the global semiconductor industry stocks plummeted, with ASML, which had a financial report bombshell, at the center of the storm. This happened against the backdrop of some top European companies suffering heavy losses. TSMC's performance announced on Thursday exceeded expectations, with positive comments on AI, and NVIDIA rebounded on Thursday, ending the week with a stable tone for technology stocks.

6. US Interest Rates

There was not much data flow from the US this week, but it leaned towards a net positive value again, mainly from the initial jobless claims and retail sales announced on Thursday.

Taking a broader view, Pasquariello turned back to a conversation he had with Josh Schiffrin, the global trading strategy director at Goldman Sachs last week, and believed that apart from their general tendency towards higher interest rates (given strong US economic growth and China's stimulus measures), if there was anything particularly prominent, it was the continued fragility on the back end (given deficit concerns, this often becomes a focal point of market attention).

This will only reinforce the preference for a steeper interest rate curve - in turn, it also supports the selection of stocks that include this expectation (favorable for financial stocks, unfavorable for stocks with duration or those seen as bond proxies).

7. US Financial Stocks

Pasquariello pointed out that last week, a Goldman Sachs PB report stated that demand for US bank stocks hit a new high in three years.

Following that, this week the demand for bank stocks continued to exist and has been bought for seven consecutive days. As mentioned earlier, a steeper US interest rate curve should be favorable for US bank stocks (mainly through higher net interest income (NII) channels; as pointed out by Goldman Sachs financial analyst Ryan Nash, US regional banks derive about 70% of their income from NII).

8. Volatility

Pasquariello emphasized an observation from last week: It is rare to see the S&P implied volatility so high when the market hits new highs (and such a high buying price deviation occurs).

Using numbers provided by John Marshall to quantify, over the past 35 years, when the S&P hit historic highs, the VIX averaged 14.9.

Although it is difficult to precisely identify what is driving the gap between current prices and volatility, we may agree on common themes: politics, geopolitics, and corporate earnings. If we were to be optimistic, a series of non-traumatic outcomes will release some risk premium.

Pasquariello believes that the best chart of the week is as follows. It shows the earnings growth over the past 12 months, which can explain why he closely monitors this when considering the excellent performance of the fundamentals of US blue-chip technology stocks

Based on the above analysis, Pasquariello believes the main theme is as follows:

• Given the inherent friendly interaction between US economic growth and the Federal Reserve, his basic view is positive.
• At the same time, risk/reward does not necessarily mean going all in now (although the policy has been fully implemented in the past month, the S&P 500 index has not shown much upward momentum).
• Therefore, Pasquariello will continue to hold heavy US stocks and keep some risk units for deployment after the election