Goldman Sachs Hedge Fund Chief: No confidence in "long and short" strategies, but the comprehensive test of the stock market has yet to come

Goldman Sachs believes that although the current market has gone through volatility, it has not yet triggered a true risk repricing.

This week, Goldman’s hedge fund business head, Tony Pasquariello, emphasized in his latest weekly market observations that while the market’s various risk indicators appear to be under control, the potential downside shock has still not been fully unleashed. Compared with past rounds of market turmoil, stock traders in this adjustment have not truly been put to the test

Pasquariello said that the statement that best captures the market situation right now is one attributed to Arnold Ventures co-chairman John Arnold, which he posted on social media:

The appeal of commodity markets is that in the end, it’s not what anyone says that determines outcomes—it’s supply and demand itself.

In addition, Pasquariello pointed out that Goldman’s data shows that in March, clients reduced positions by the largest amount in 13 years, and when April arrived, the overall market was in a state of sizable net short positions.

Even so, he clearly recommended that the top priority is to preserve capital and wait for the next clear entry signal. He said:

In times of crisis, the opportunity to make big money often comes after the crisis.

Risk premium is modest, but the “worst moment” may not be here yet

Pasquariello noted that based on multiple quantitative indicators, the “intensity” of this round of market turbulence is lower than expected.

Forward volatility, the relative performance of cyclical stocks versus defensive stocks, and the credit spreads for investment grade, have all not widened as dramatically as in historical crisis periods.

Pasquariello said:

I’m not saying March was calm. What I mean is that stock traders haven’t truly experienced a comprehensive test yet.

Regarding the market’s resilience right now, Pasquariello laid out two opposing interpretations.

The optimistic camp believes the market has not lost confidence in the continued sustainability of U.S. economic growth.

Data from Goldman strategist Ben Snider provides support: the S&P 500’s 12-month forward earnings per share expectations have been revised up by 6% since the peak, and have also risen by 3% since the outbreak of the conflict. The ongoing improvement in earnings expectations provides fundamental support to the market.

The cautious camp, meanwhile, believes the market is merely overconfident, and that the real shock has not arrived yet.

Tony Kim of Goldman noted that at the end of February, the last batch of oil tankers that transited the Strait of Hormuz have only just arrived at their destinations in East Asia and Western Europe. The shock from a shortage of physical energy supply is starting to truly ferment from now, and the most explosive convexity range in energy prices has not been released yet.

Pasquariello admitted that he does not have sufficient conviction in either the bullish or bearish view. This week, the S&P 500 recorded a strong rebound in the backdrop of energy prices rising again; this combination alone reflects deep internal tensions within the market.

A shock from a shortage of physical energy supply may soon become concentrated

Beyond subjective judgments, Pasquariello cited objective data from Goldman drawn from its own business.

Goldman’s prime brokerage data shows that in March, the sell-side volume by hedge fund clients was the highest in nearly 13 years. This means that by March, the trading community had already substantially cut long exposure and entered April carrying sizable short positions.

Pasquariello believes that although this data cannot guarantee conclusions about any direction, and only represents a specific type of market participants, it shows that the current tactical risk-reward structure is now relatively more balanced than it was a month ago.

He attributes the core contradiction at present to: the market is facing the largest oil supply disruption in history, yet at the same time, a single major headline-type piece of news is enough to trigger a violent short-covering move. He calls this situation “strategic ambiguity.”

On the volatility front, Pasquariello believes that even if the VIX has peaked, downside tail risks and upside tail risks remain present in parallel:

• On the one hand, if a crisis continues to evolve into a broad economic growth shock, downside risks cannot be underestimated;
• On the other hand, once a “down-step” style diplomatic or policy turnaround appears, upside tail risks also cannot be ignored.

Based on this assessment, he maintains a conservative stance, emphasizing that the priority right now is to preserve capital and keep the capacity to respond for the opportunities in the next phase.

Preserve capital first, and wait for the layout window after the crisis

Looking ahead, Pasquariello expects three major themes to continue driving the market after risk is resolved:

First, the AI investment boom won’t fade. It’s easier to identify the direction than to execute. Pasquariello said he will stick with a paired-trade strategy of pairing AI leaders against laggards.

Second, demand for power and infrastructure financing will exceed earlier expectations. A similar pattern to 2022 is emerging again. The structural costs of insufficient long-term investment in basic industries and a lack of supply chain diversification are being realized, and the strategic value of energy infrastructure will become even more prominent.

Third, the resilience of Japan’s stock market deserves attention. Japan’s stock market is both cyclical and highly dependent on energy imports, and it is also heavily held in traders’ portfolios. With multiple adverse factors overlapping, the performance over the past month has still been impressive. Pasquariello believes that the two major themes—AI and defense—that attract capital inflows into Japan will continue into the next stage.

To conclude with Darwin’s theory of evolution, Pasquariello ends this week’s market observations with:

It’s not the strongest or the smartest who survive, but those who are best able to adapt to change.

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        The market involves risk; investing requires caution. This article does not constitute personal investment advice, and it does not consider any specific investment objectives, financial situations, or needs of individual users. Users should consider whether any opinions, viewpoints, or conclusions in this article align with their specific circumstances. Invest at your own risk based on this.