Author: Pan Lingfei, Wall Street News
The U.S. stock market in July was not a crash at the index level, but more of a clearing at the position level. The S&P 500 held its ground this week, with its entire July trading range being just 3.5%, less than 2% away from its highs. More counterintuitively, the equal-weight S&P 500, the low-volatility S&P 500, and the S&P 500 excluding AI stocks all hit record highs this week.
Tony Pasquariello, head of Goldman Sachs' hedge fund business, wrote in his latest market observation: "Following a truly parabolic move in high-momentum trading, the past month has seen a heavy hammer smash through consensus positions; I am inclined to think the fever has broken." The key is not that the risks have disappeared, but that the most crowded, most convenient, and most leveraged trades have been forced to cool down.
Surface calm and underlying intense volatility coexisted. The S&P 500's daily moves averaged less than 1% this week, while Goldman's flagship momentum basket saw daily moves approaching 10%. On June 22, Goldman's TMT momentum basket was still up 145% year-to-date, then experienced its worst drawdown on record, only to rebound 17% in a single day later. Asian fundamental long-short funds posted record performance in the first half of the year, then suffered their biggest monthly drawdown in a decade, while South Korea's KOSPI rallied 18% overnight.
This framework leads to a somewhat uncomfortable conclusion: The outlook for U.S. stocks remains favorable, but risk/reward is no longer cheap, and the upside elasticity of global equities is weaker than before. The bull market has not been disqualified, but the coming phase is not one of 'buy and hold.'
Indexes Hold, Crowded Trades Collapse First
The easiest misjudgment in July was focusing solely on the S&P 500.
The index did not signal panic. The S&P 500 is less than 2% off its highs, with a July range of only 3.5%, appearing to be in normal consolidation. But active managers underneath have experienced another kind of market: hot momentum, AI chain, Korean stocks, Asian long-short strategies were successively squeezed out by leverage.
The problem is not how much it fell on any given day, but that the previously most profitable trades suddenly lost liquidity. Betting on the S&P 500 itself shows stability; betting on high-momentum tech stocks shows near-uncontrolled volatility.
The key divergence in July lies here: The waves at the index level are not big, but a batch of ships have already capsized at the position level.
Deleveraging is Not a Minor Adjustment, But a Real Washout
A few data points illustrate that this deleveraging has gone beyond ordinary portfolio adjustments.
Global technology exposure saw its largest selling in over five years. Assets under management in Korean stock leveraged ETFs, which were $53 billion at the June peak, have now fallen to $15 billion. Goldman's prime brokerage business saw the largest gross exposure reduction since late 2022.
Finer position changes also point in the same direction: Fundamental long-short clients' leverage exposure to momentum factors has fallen to the 28th percentile of its one-year range. Crowded trades have gone from "everyone on board" to a significant portion having already gotten off, or even being forced off.
This does not mean painful trades won't return. Just compared to early July, there is noticeably less chasing impulse in the market, and significantly more cash and discipline.
The Contradiction of AI Trades Shifts from Narrative to Return
In the latter half of July, the AI trade did not face simple profit-taking, but a more fundamental question: Can the massive AI capital expenditures by hyperscale cloud providers generate sufficiently clear and sustainable returns?
Market doubts about this question intensified last week. The answers given this week were mixed, but better than the most pessimistic version.
Meta did not demonstrate significant AI returns are already in hand; Microsoft gave clearer signals that capital expenditures are translating into revenue and AI products, and at scale; Amazon subsequently delivered results showing AWS growth re-accelerating and cloud business margins expanding. Credit spreads on hyperscale cloud provider bonds narrowed concurrently.
These changes are important. If the AI trade only had "huge investments, distant returns," valuations would be under pressure; but if some companies can prove that investments are starting to become revenue, the market won't treat the entire AI chain uniformly.
However, differentiation has emerged. The stage where simply having an AI label could boost valuations is, at least after this washout, not so easy anymore.
Fed Communication Darkens, Long-End Rates Become a Stock Market Headache Again
After the FOMC meeting, equity traders were not much more at ease. Volatility in the long end of the U.S. Treasury curve briefly spilled over into the stock market.
More troublesome is the change in communication style. The market was accustomed to relatively high transparency in the past; now it's more like entering a more restrained, less explicit phase. Traders must judge policy direction with fewer clues, which itself creates friction.
What really needs focus is the policy direction, not every word. But for stocks, changes in long-end rates cannot be ignored, especially for long-duration stocks. Valuations for AI, tech, and growth stocks are more sensitive to long-term discount rates. If global long-end bond yields continue to exert pressure, a "stable foundation" doesn't mean comfort every day.
U.S. Stocks Still Favorable, But Upside Elasticity Thins
From a broader framework, U.S. stocks have not lost their support. The economy is performing well, earnings growth is strong, fund flows could turn more positive, and nearly $1 trillion in AI capital expenditures is still flowing through the system.
This explains why the S&P 500 held up while underlying deleveraging was intense. It's not that the index is without risk, but that there are enough supporting factors simultaneously holding it up.
But this is not a signal for aggressive bullishness. The direction for U.S. stocks remains favorable, risk/reward is in the middle range, and the upside elasticity for global equities to rise significantly further is weaker than in the previous phase.
More volatility lies ahead in the short term. Summer liquidity is not favorable for risk transfer; once certain positions are crowded, illiquid, and structurally complex, volatility can be amplified. At the portfolio level, it's more suitable to increase liquidity and reduce complexity than to continue chasing the steepest trades.
The Nasdaq's Answer: Bull Market Still Intact, The Path Will Be Bumpy
The Nasdaq 100 index is currently down 8% from its June high, but is still up 12% year-to-date. It has declined in 6 of the past 9 months, yet is up 9% point-to-point. Its P/E ratio has fallen back to the lower end of its range over the past few years.
These numbers tell the market state clearly: The trend is not broken, but the process is painful.
For trading, the destination and the path are not the same. The Nasdaq's primary bull market is still on, but if the future continues with a rhythm of "rally for a while, smash positions in a round, then recover," making money is harder than getting the direction right. July already gave a reminder: The market does not reward crowding, nor does it forgive leverage.
