Source: Wall Street News

As of this Thursday, the S&P 500 index had risen by more than 6% in the last six trading days, completely recovering all losses during this month, including last week's “Black Monday,” and was only 2.2% different from the previous month's closing record high. Last week's sharp drop seemed like yesterday's yellow, and everything went back to square one.

Tony Pasquariello, a top trader at Goldman Sachs and global head of the hedge fund business, pointed out in a recent report that the story of the past 10 days was that nothing the market feared, that recent volatility shocks did not make a comeback, and there were no major events at night during the US period. Whether viewed at the macro or micro level this week, it was all positive, because believing in this judgment, the US stock market has clearly stabilized. But would that give you peace of mind?

Pasquariello said that this week he began thinking about whether to view this period as a watershed, that is, when there are certain changes within the system. He advised investors to stabilize their portfolios as next fall will be “unusually busy.” He wrote:

“As we get through August, when liquidity is scarce, and enter an unusually busy fall season, I expect the trading environment to remain volatile, so I will keep my portfolio stable and reduce my assets to the highest quality assets.”

Pasquariello lists the following eight points of interest:

What narrative will market participants attach to next?

There has been a lot of narrative fluctuation lately. Since late March, the narrative has changed from a re-inflationary deal, an assumed soft landing, to minor financial pressures, to a significant local tone of resilience. Pasquariello speculates that the market will continue to fluctuate from topic to theme, and he won't wait until a clear narrative will continue until the US election.

The Federal Reserve

Before the Jackson Hole Global Central Bank Annual Meeting next week, Goldman Sachs predicts that the Federal Reserve will decide to cut interest rates by 25 basis points in a row at the next three meetings in September, November, and December, then cut interest rates once every quarter of next year, and again until 2026, or the following year. Ultimately, the Federal Reserve's policy interest rate, the federal funds rate, should be about 200 basis points lower than the previous 13-month level of 5.375%.

If the Federal Reserve were to act more aggressively than predicted above, it might require a shockingly poor employment report or a drastic tightening of the financial environment. The current financial environment is relaxed compared to last year's average.

US economy

The data released this week is once again positive, particularly CPI, retail sales, and the number of people applying for unemployment benefits. Looking at it from a broader perspective, US economic growth has objectively slowed since the end of last year, yet American economists at Goldman Sachs still don't believe that it will fall into recession in the near future.

American consumers

Judging from the micro and macro information received this week, the overall consumption situation in the US is not as bad as the market feared. If you don't believe me, please take a look at the stock price performance of Walmart (WMT) and Home Depot (HD).

From a broader perspective, US consumption has clearly slowed in recent months, and at the low end, there is clear pressure. Pasquariello did not deny that there is a downturn, but pointed out that the US is still in a fully employed environment, actual household disposable income is still growing, household balance sheets are at the strongest level in history, and household net assets have increased by more than 50 trillion US dollars during the COVID-19 pandemic.

Overall, the current environment is riskier than it was earlier this year, yet Pasquariello doesn't believe US consumption has bottomed out.

Cash Flow/Positions

First, judging from a very high starting point in July, Pasquariello believes that since the July high, speculators have cleared quite a few long positions, which is clearly reflected in Goldman Sachs' main broker business and CFTC reports on index positions.

Second, neither families nor fund managers who only go long have lost their courage after experiencing the recent stock market shocks. Finally, US stocks have returned to the best position for share repurchases. Stock repurchases increased significantly last week, probably about 5 billion dollars per day.

All in all, although Pasquariello is still watching the remaining long positions, the current capital flow is a net success factor for the market.

Japan

Last week's “Black Monday” trading on August 5 was crazy, and Japanese stocks have already fought back amazingly. Goldman Sachs's strategy team's view on Japanese stocks is that they have declined but are not out of the game.

According to Pasquariello, the basic bullish view on Japanese stocks still has value: shareholder reform, negative real interest rates, and the right combination of structural winners (semiconductors, defense). Having said that, he is now concerned about capital flows. Goldman Sachs saw its biggest sell-off in five years last week's franchise capital flow. He suspects that the risk-reward ratio will remain unclear for some time.

Pasquariello quoted Goldman Sachs Asian franchise expert John Joyce as saying:

“It takes about three months for the escalator to rise. It will take three days for elevators to drop... Trading like in emerging markets will only increase scrutiny of Japan's future narrative, and the strategist's job will be more difficult.

The benefits of a weak yen will be questioned, and valuation expansion will need to be profit-centered, which will make Japanese transactions lose the 'easy' part.”

Joyce said that there may be a paradigm shift in the Japanese trading community, favoring individual stock alphas. Dollar-based stock selectors who are worried about the depreciation of the yen have now eased their concerns, and they need to have confidence in sustainability.

An uninterrupted trend

Pasquariello said he is always attracted to trends that don't break when the trading mechanism changes. He mentioned before that Goldman Sachs's high-quality companies are trading pairs with low-quality companies. When he admits he doesn't have much confidence in the overall direction of the market, he won't overlook this theme.

US one-year interest rate, one-year forward interest rate chart

Pasquariello anticipates that the fluctuation range shown in the above chart will continue for longer, but the asymmetry thereafter will clearly bias towards the lower end of the distribution range.

Based on the above, Pasquariello's view on the risk-reward ratio of the market is:

• The US economy is enduring, and the Federal Reserve will cut interest rates by a total of 200 basis points. This is a healthy macro environment for risky assets.

• At the same time, however, the market will continue to watch the growth trajectory and political/geopolitical news.

• Also, the narrative around artificial intelligence (AI) isn't as one-sided as it was a few months ago.

Editor/jayden