The ongoing two-month selloff in US stocks is poised to intensify further as a combination of factors, including the stance of options dealers on Wall Street and fast-money traders, casts a shadow of uncertainty over the market’s future. These warnings come from the experienced perspective of Scott Rubner, a seasoned analyst at Goldman Sachs Group Inc., with a two-decade track record of studying fund flows.
Amidst the turmoil, major stock indices like the S&P 500 have broken below critical thresholds, placing trend-chasing systematic funds in a precarious position where they might be compelled to liquidate their equity holdings.
Rubner’s analysis reveals that commodity trading advisers, who actively navigate asset price momentum through long and short bets in the futures market, are set to offload an estimated $48 billion worth of global stocks within the next week, even if market benchmarks remain relatively stable.
At the heart of the market’s current predicament lies the behavior of market makers — entities capable of transacting millions of shares to hedge their portfolios. They find themselves entangled in a situation where they are forced to align with the prevailing trend, selling stocks as they decline and buying them when they rise. This exacerbates price fluctuations in both upward and downward directions.
This positioning, known as “short gamma,” has now reached its most extreme level since Goldman Sachs started tracking this data in 2019. In a note, Rubner, a managing director at the bank, emphasized, “This is a no rules market, and flows over fundamentals are the drivers of price action into the end of the quarter. This dynamic remains negative in the ultra-short term.”
Recent market movements reflect this instability. On Wednesday, stocks managed to recover from an earlier 0.8% drop, allowing the S&P 500 to close the session flat. However, the benchmark index has already shed nearly 7% from its 2023 peak in July, primarily due to the Federal Reserve’s commitment to maintain higher interest rates, thereby adding pressure to stretched valuations. Along this journey, the index has breached support levels at the 50-day and 100-day moving averages.
While the recent retreat has been relatively orderly, it contrasts starkly with the summer’s tranquil period. Over the past five weeks, the S&P 500 has experienced four separate sessions with 1% declines, following a 47-day streak without such a drop through August 1 — the longest run of resilience since January 2020.
Goldman’s assessment aligns with the concerns expressed by Morgan Stanley’s trading team, which cautioned last week about the market’s growing fragility. They pointed to a similar positioning dynamic among options traders and momentum-chasing quant funds. Amidst the focus on Federal Reserve policy and the potential government shutdown, this analysis underscores the increasingly complex technical backdrop on Wall Street.
On the flip side, if stocks begin to rally once more, options dealers would need to chase the market to maintain a market-neutral position. Consequently, they possess the potential to ignite market movements in both directions. According to Goldman’s model, a 1% market shift could translate into $3.3 billion worth of share buying or selling.
Scott Rubner anticipates the formation of a market bottom in the first half of October, followed by a year-end rally driven by favorable seasonal factors and an uptick in corporate buybacks. Approximately 90% of S&P 500 firms are expected to enter an earnings-related blackout by the end of the week. Historically, this has resulted in increased share repurchases in November and December, which typically represent the busiest two-month period of the year, constituting 21% of the annual total, according to data compiled by Goldman.
Rubner’s optimism shines through as he concludes, “The positive setup for Q4 is about as good as I have seen once we clear this flow-of-funds supply. I will sound the alarm bells when the ‘elevator is down, and we can ride the escalator up’ into the end of the year.”
In conclusion, the shifting sentiments of Wall Street money traders have cast a shadow of uncertainty over the future trajectory of the financial markets. As the market navigates these challenging waters, investors and analysts alike will remain vigilant, closely monitoring the ever-evolving dynamics of the financial landscape.
Source: Bloomberg
