Goldman Sachs: The "rush to junk stocks" trend will continue until Trump's inauguration, with the most shorted U.S. stocks being favored

Before the trading pause on Tuesday due to Trump, as of Monday, a basket of the most shorted stocks tracked by Goldman Sachs had cumulatively risen over 11% in five trading days. Goldman Sachs' trading department expects this phenomenon of popularity among the most shorted stocks to continue until January next year when Trump is sworn in as president.

A report from Goldman Sachs trader Guillaume Soria states that the trading department believes that by the end of this year, the stocks with the highest short interest, as well as lower-quality stocks including high floating rate bonds and low momentum stocks, will face increased risk of repricing.

The report stated:

“We are entering a pro-cyclical environment (our cyclical stock and defensive stock combination achieved the second-best one-day performance ever), and short-term interest rates are gradually declining.”

Goldman Sachs analyzed the returns, Beta values, leverage, momentum, dividend yields, and other indicators following the election of Republican candidates in 2000, 2004, and 2016, finding that the factor returns when Republicans are elected indicate that previously underperforming stocks and high Beta stocks will increase in scale. Beta stocks tend to trade well, and large-cap stocks have a 100% hit rate of underperforming small-cap stocks, while momentum often performs poorly, and value and yield outperform growth.

Therefore, Goldman Sachs recommends continuing to hold the most shorted stocks until the end of January next year, as they anticipate:

• Lower interest rates,
• The U.S. economy avoiding recession,
• Elimination of election uncertainties,
• Trump's overwhelming victory bringing a rebound driven by "animal spirits," providing a favorable environment for low-quality stocks.

Goldman Sachs' report points out that over the past decade, the three months when low-quality stock baskets performed best each year are January, June, and November, with the current November and next January accounting for two of them.

Goldman Sachs found that since the large-scale reduction/recovery in July this year, short positions have generally been increasing and are at a year-to-date high, leaving room for short covering before the end of the year.

The report mentions that Goldman Sachs' high floating rate bond basket has broken upward compared to the S&P 500 index, breaking a downward trend that lasted over four years. The combination of cyclical and defensive stocks has achieved the best performance since 2020. Momentum is entering the three-month phase of the year when this factor performs the worst: from November to January.

The trading situation of previously underperforming stocks aligns with this year's heavily shorted stocks, both impacted by rising long-term interest rates, which should now ease.

Additionally, Goldman Sachs traders recently expect that after the trading frenzy driven by the U.S. election ends, rotation pressure will continue to be a significant feature of the U.S. stock market, as investors allocate funds to small-cap stocks and seek opportunities in cyclical/inflation themes. Goldman Sachs trader Mike Washington stated that with the elections and the Federal Reserve and the Bank of England each cutting rates by 25 basis points, the yield on 10-year U.S. Treasuries fell 7 basis points to 4.30% within a week, and the volatility of yields has adjusted, revealing investor fatigue during the long earnings reporting cycleGoldman Sachs strategists continue to favor risk in asset allocation, increasing holdings in U.S. stocks and high-yield bonds while reducing exposure to Europe. In a report on Monday the 11th, strategists including Christian Mueller-Glissmann wrote that the reset of implied volatility means investors should look for specific hedges or options overlays, as the bond sell-off may put pressure on stocks