Goldman Sachs: It doesn't matter if the U.S. avoids a government shutdown; there is greater room for selling in the U.S. stock market in the future

Goldman Sachs Managing Director Nelson Armbrus believes that 2024 will be a "difficult year" for many, and he does not expect much improvement in 2025. He reminds clients that Darwinism is indeed very applicable in financial markets.

Although the U.S. Congress managed to avert a government shutdown at the last minute last weekend, Armbrus does not think that the U.S. fiscal issues have eased, and he believes that there will be greater selling pressure in the future. Starting this week, U.S. stocks are entering a period of low liquidity and intense year-end holidays. In a recent report, Armbrus mentioned four things to watch:

Last Friday's Trading Volume Hit a Record High

On December 20th last Friday, the trading volume across all U.S. stock exchanges was 23.5 billion shares, marking the second-highest single-day trading volume in U.S. stock history, only behind the peak of retail bets on GameStop (GME) against Wall Street on January 27, 2021, which was 23.67 billion shares.

Last Friday, U.S. stocks also faced the last major liquidity event of the year, with trading volume surging due to quarterly rebalancing and a large number of options and futures concentrated on "Triple Witching Day." On that day, the Market on Close (MOC) imbalance for the S&P 500 Index was extreme, with sell orders reaching $12.1 billion, indicating a significant sell-off.

In the three trading days leading up to last Friday, the total sell orders for the MOC at the close of the S&P Index amounted to $20.3 billion, with Friday's figure being three times that of the previous two days, which were $4 billion and $4.2 billion on Wednesday and Thursday, respectively.

Additionally, Goldman Sachs' Prime Brokerage (PB) data shows that the nominal value of hedge funds shorting U.S. stocks from last Monday to Thursday was the largest since early January this year, ranking 100th in the largest scale over the past five years.

Last week, the short positions in ETFs increased by 8% compared to the previous week, marking the largest percentage increase since April 2020.

Commodity Trading Advisors (CTA) Will Sell Off

After the Federal Reserve's hawkish stance last Wednesday, Goldman Sachs estimated that the fund flows of CTAs shifted from small sellers to medium buyers. Goldman estimates that as of last Thursday's close, over $9 billion flowed out of E-mini S&P 500 futures last week, and about $4 billion flowed out of E-mini Russell 2000 futures, both of which will impact the market, especially considering that many people will be on vacation, leading to very low liquidity in U.S. stocks.

As of last Thursday, CTAs held $41.8 billion in long positions in E-mini S&P, which is at the 82nd percentile of historical holding levels. The long positions in E-mini Nasdaq 100 and Russell 2000 are similar, indicating that: there is a lot of room for selling, but little room for buying.

However, Armbrus pointed out that he expects the trend of U.S. stocks to rise by the end of the year.

The U.S. Government Avoided a Shutdown but Faces Greater Fiscal Challenges

In the early hours of last Saturday, the U.S. Congress passed a bill that authorizes a short-term extension of government spending until March 14, 2025, without mentioning a suspension of the debt ceilingCongress may attempt to resolve the debt ceiling issue early next year, but the deadline for action on the debt ceiling could be between July and August next year.

To gain Republican support for the bill while meeting the demands of incoming President Trump to raise the debt ceiling, Republican leaders have promised to increase the debt ceiling by $1.5 trillion in a "reconciliation" bill next year, while cutting $2.5 trillion in spending over ten years, which accounts for 0.7% of GDP. Goldman Sachs estimates that the $1.5 trillion increase will push the debt ceiling deadline from July and August next year to January and February 2026. However, the exact timing will depend on the Treasury's cash flow at that time.

Goldman Sachs believes that the next important issue in fiscal policy will be whether Republicans in Congress will attempt to pass a "reconciliation" bill next year or within two years. The advantage of a two-step approach to fiscal spending is that it allows for the quick passage of some priorities, such as increasing funding for immigration enforcement, and possibly raising the debt ceiling, followed by a second bill to extend expiring tax cuts and implement any new tax cuts from Trump's campaign plan, while offsetting these expenditures with any budget savings agreed upon by Republicans.

In contrast, if these issues are bundled into a single plan, a one-step strategy may win support from Republicans who want to increase immigration enforcement, but the resulting fiscal issues are the most concerning. Currently, Republicans are more likely to adopt a two-step strategy rather than a comprehensive package.

Armbrus mentioned that the government efficiency department DOGE, led by Trump and Musk, has not yet officially taken power. However, they have influenced the initial $1,500 spending bill, reducing its content to 116 pages. If you are not optimistic about the U.S. economy next year, such concerns are indeed warranted.

Investors Bet on Increased Volatility on Trump's Inauguration Day

Last week, the Fed's hawkish stance after the meeting drove a broad rise in option prices.

Judging from the daily prices of S&P 500 options, investors are clearly betting on Trump's inauguration day in January next year, buying related options, and last Friday's sell-off was to fund this trade