Goldman Sachs sees the potential for a rally in US stocks. What will push them up?

Positions of hedge funds in the U.S. stock market have created such conditions, according to which after recent fluctuations, the stock market may sharply go up, according to the trading division of Goldman Sachs, writes Bloomberg. At the same time, analysts at 22V Research and Boston Consulting warn that geopolitical risks and rising oil prices may, on the contrary, increase volatility and provoke a deeper correction in the market.

In trading on March 12, the S&P 500 is down 1.3%, the Nasdaq Composite is losing 1.65%, and the Dow Jones is down 1.34%.

Speculative investors mostly maintained bullish positions on individual stocks, while building up hedging through bearish bets on exchange-traded funds (ETFs) and stock index futures, data from Goldman Sachs' prime brokerage unit showed. On March 11, the volume of short positions on such instruments reached its highest level since September 2022, the bank noted.

This dynamic reflects uncertainty in the market, but it could also lead to significant gains if positive news encourages investors to close hedging positions, according to John Flood, head of equity transactions for the Americas and partner at Goldman.

"If there is a headline about the end of the conflict [in the Middle East], you could see a sharp upward movement in the index levels. The growth could be 2-3% almost in a straight line, and most of this movement will be due to the closing of short positions," Flood said.

The aggregate exposure of hedge funds (gross exposure) - an indicator reflecting the total value of long and short positions - was almost at an all-time high on March 11, the bank said. At the same time, "the risk of upward movement [of market quotes] is now more pronounced - extreme - than the downside risk," Flood said: "We see a significant volume of shorts (bets on market decline) in macro instruments, any positive headline could trigger aggressive closing of short positions," he added.

Investors, Bloomberg notes, could already feel similar dynamics on March 9, when U.S. President Donald Trump said that the war with Iran could end "very soon". The S&P 500 Index closed the day up 0.8% after falling 1.5% during the session. Much of the reversal was due to the fact that market participants bought back securities on which they had previously opened short positions, writes Bloomberg.

At the same time, reduced liquidity in the markets is likely to exacerbate equity volatility in the coming weeks, Flood said. While trading volumes have risen to more than 20 billion shares a day this year, the depth of liquidity - a measure of how easy it is to execute large trades - has fallen sharply, he added.

A Goldman Sachs partner estimates that the volume of S&P 500 Index futures that can be bought or sold at the best price in the stack (called the upper order book depth) is now about $4 million, while the historical average is about $14 million. Values below $7 million usually signal market tightness, Bloomberg explains.

"This means that every time a large institutional investor tries to buy or sell a significant amount of [assets], their transaction has a much bigger impact on the price," Flood said.

Further market dynamics will largely depend on how the conflict in the Middle East will be resolved. For now, investors expect that the uncertainty caused by the war in Iran will soon begin to subside, Flood says: "The market is counting on some signal of the situation's resolution within the next two weeks. If the conflict drags on longer and there is no positive progress, it will be a problem for the equity market at the index level," he added.

"I think what we've seen [in the stock market in recent weeks] <...> is just the first stage of a deeper correction," Barron's quoted John Rock, an analyst at 22V Research, as saying. From its Jan. 28 peak of 7,000 points, the S&P 500 had lost more than 4% by March 12.

"It would be foolish to ignore the full range of geopolitical risks," noted Philip Carlsson-Schlesak, chief global economist at Boston Consulting Group.

According to forecast macroeconomic models, for the U.S. economy, a rise in oil prices to $120 per barrel for one quarter would have a negligible effect, Barron's writes: in such a case, U.S. GDP would fall by about 0.15% and inflation would rise by 0.85%. However, there are too many variables at this stage to confidently assume that oil prices will not put pressure on the economy, the publication notes.

"The key question remains not 'how high' [the price of oil and other energy commodities] will rise, but 'how long' [they will stay high]," says Karlsson-Schlesak. - A few days of oil at $300 would be far preferable to a few months at $150."

In addition, the decline in stock prices - whether due to inflationary fears caused by the war or other factors - weakens the so-called wealth effect, where falling asset values reduce consumer spending, Barron's notes, emphasizing that this, in turn, reduces consumer spending. Ultimately, the war may not lead the U.S. economy into recession, but the risk of such a scenario has increased markedly, the publication points out. Karlsson-Schlezak estimates its probability at about 25%, while before the crisis, according to his estimates, it was about 15%.

On March 9, analysts at JPMorgan warned that the S&P 500 index could fall 10% from its January peak due to the ongoing conflict in the Middle East.

Since the escalation of the conflict in the Middle East began on February 28, the S&P 500 has lost about 2.5%, the "technology" index Nasdaq Composite - 1.6%, and the index of "blue chips" Dow Jones - more than 4%. Brent oil during the same time rose in price by almost 39%, 10 percentage points of which it added on March 12, jumping to more than $101 per barrel. Futures for U.S. WTI crude oil Mark with delivery in April also rose 10% in trading on Thursday, reaching $96.2.

This article was AI-translated and verified by a human editor