Goldman Sachs: Market Still in 'Post-Deleveraging Ruins,' Risks Not Yet Cleared; Recommends Proactively Buying Protection

Goldman Sachs' top trading team warns that the market is undergoing a violent unwinding of momentum and positioning. Although the deleveraging process is nearing its end, risks have not been completely cleared. Multiple key events will continue to suppress volatility, and in the current market landscape, the cost-effectiveness of proactively buying protective positions is rising.

On July 29, Gail Hafif, Brian Garrett, and Lee Coppersmith from Goldman Sachs' Prime Brokerage and Flow Strategy team described the market state since July as "encountering monsoon and tsunami warnings during a beach vacation" in the latest issue of their "Flow Show" report.

The report points out that the market has experienced a significant momentum pullback and position reduction in recent weeks. Although overall institutional positions have been somewhat cleaned up, total global leverage remains at the 93rd percentile over a five-year lookback period, meaning substantial de-risking has not yet been completed. Meanwhile, retail activity is beginning to cool down, while corporate buybacks are returning to the market; this force will become the most stable and reliable buying support in the short term.

Looking ahead to August, upside potential is expected to be limited by seasonal fund outflows, insufficient institutional offensive willingness, and dealer positive Gamma positioning suppression, leading to an overall range-bound pattern for equities. Additionally, at the systematic strategy level, the S&P 500 has fallen below short-term trigger levels. If prices continue to decline, selling from the CTA community will be unlocked, and the scale of selling in downside scenarios far exceeds buying in upside scenarios. Flow estimates show clear asymmetry—if the market falls in the coming week, systemic selling could reach $24.9 billion, far exceeding the approximately $2.3 billion in buying in an upside scenario.

Against this backdrop, the Goldman Sachs trading team offers three core recommended trades: going long on correlation (anti-dispersion strategy), buying three-month put options on IWM, and arranging short-term option protection for GSXURFAV retail favorite stocks. They explicitly stated that as the probability of macro-level correlation converging to one (Corr1) events continues to rise, single-stock volatility remains high, and the window for buying protective trades is opening.

Deleveraging Enters "Late Stage," But Market Still Trudging Through Ruins

The Goldman Sachs trading team pointed out that the market has experienced significant momentum and positioning unwinding in recent weeks. Although this round of de-grossing may have entered its late stage, several key events remain unresolved ahead—including geopolitical situations, Federal Reserve policy directions, and the corporate earnings season—which will continue to maintain high market volatility.

From institutional positioning data, global gross leverage remains at the 93rd percentile over a five-year lookback and the 65th percentile over a one-year lookback. This data reveals a key contradiction: although there has been obvious deleveraging recently, from a longer-term perspective, institutional positions remain extremely crowded, and substantial de-risking has not yet occurred.

The report specifically highlighted that the global Information Technology sector is under the most pressure. On Goldman Sachs' internal Prime Book, the scale of long selling in global Information Technology last Friday was the largest since September 2024, with a Z-score of -3.6, representing one of the largest reductions in the past five years.

The report believes that the burden at the positioning level no longer constitutes market resistance, and healthy trades driven by fundamentals are expected to gradually return. "However, before discussing any substantial re-leveraging, we still need to traverse the ruins left by the past few weeks."

Flow Dynamics: Retail Cools, Passive Funds Hit Records, August May See "Buyer Strike"

The Goldman Sachs trading team clearly judges that the stock market will maintain a range-bound pattern in the short term. From the structure of capital flows, the team believes that August faces multiple headwinds, lacking "fuel" for upward movement.

On one hand, mutual funds historically have a pattern of holding cash before midterm elections and deploying it concentratedly after the elections. This means that this buyer group will contribute little to US stocks before the votes are counted. Overseas investors also tend to moderately reduce their holdings of US stocks from now until one month before the election.

On the other hand, August and May are tied as one of the worst months for net stock outflows from mutual funds and ETFs in history. Rising geopolitical concerns, energy price pressures, and monetary policy uncertainty are paving the way for a "temporary strike" by buyers in August.

Notably, year-to-date, stock ETFs and mutual funds have recorded their largest inflow since the beginning of the year, totaling $659 billion.

Among these, passive equity funds saw net inflows of $742 billion year-to-date, while actively managed funds saw net outflows of $83 billion, reflecting the extreme enthusiasm of retail investors for momentum and leverage this year.

In July alone, $34 billion flowed into US equity funds, marking the third-largest inflow for a July in over 20 years.

The Goldman Sachs traders team expects this momentum to cool significantly in August, and early signs are already appearing.

Gamma Structure Suppresses Upside, Downside Will Be Amplified

The Gamma structure in the options market further reinforces the judgment of a range-bound stock market. Goldman Sachs data shows that dealers currently hold positive Gamma on the S&P 500, with more Gamma on the upside and less on the downside.

This pattern means that volatility on the upside will be suppressed, making it difficult for the market to form a smooth rise; however, during declines, Gamma positions will amplify the downward magnitude. Nevertheless, the Goldman Sachs trading team believes that major downward moves are likely in their late stages.

Pressure from systematic strategies is also not to be ignored. The S&P 500 has fallen below Goldman Sachs' estimated short-term trigger level of 7,453 points. Once prices continue to fall, systematic strategies such as CTAs will unlock selling. Currently, systematic strategies hold approximately $196.3 billion in long US equity positions, ranking at the 48th percentile over a three-year lookback, while CTA positions are at the 44th percentile. In the context of weakening market liquidity, the incremental potential selling volume will have an amplifying effect.

Goldman Sachs' quantitative estimates show that in the coming week, if the market is flat, net selling will be about $1.3 billion; if it rises, net buying will be about $2.3 billion; if it falls, net selling will reach as high as $24.9 billion—the huge gap between these three scenarios clearly presents the current downward skew in capital flows.

Goldman Sachs specifically pointed out that as market liquidity weakens, the impact of selling will be amplified, and flow forecasts show clear asymmetry in downside scenarios.

Corporate Buybacks Provide Most Reliable Support

Amidst these multiple headwinds, corporate buybacks have become the structural support force most valued by the Goldman Sachs team.

Report data shows that currently about 31% of S&P 500 constituents (by count) are in open buyback windows; this proportion is expected to rise to about 53% by next weekend; and by mid-August, over 90% of constituents will enter the open window.

Goldman Sachs expects that as more companies exit the earnings quiet period and actively implement buybacks using the post-earnings open window, discretionary buyback demand throughout August will see a significant jump.

The report characterizes this as "the most supportive and reliable capital flow for US stocks in August," helping to maintain a continuous buying floor while investors digest the aftermath of deleveraging.

Corr1 Risk Heating Up: Narrowing Spread Between Single-Stock and Index Volatility Is a Warning Signal

This is the most warning part of the report regarding market structure.

Goldman Sachs pointed out that the S&P 500 Index's 1-month Implied Correlation has risen slightly during the recent decline. Previously, single-stock volatility was at historical highs, while index volatility was relatively low, forming an unprecedented spread between the two. As single-stock volatility retreats from highs, this spread is narrowing.

Against the backdrop of continuing macro uncertainty and the market washing out momentum enthusiasm, the probability of a Corr1 event (an extreme risk event where market correlation surges close to 1, causing individual stocks and the index to plummet in sync) is rising and has entered the risk radar of market participants.

Regarding small-cap stocks, Goldman Sachs noted that the Russell 2000 (IWM) has historically performed weakly in the first two weeks of August, a pattern likely to continue this year. Uncertainty in monetary policy and geopolitics will create superimposed pressure, and the index's relative strength year-to-date also implies room for correction.

Based on the above analysis, the Goldman Sachs trading team (Gail Hafif, Brian Garrett, Lee Coppersmith) provides three specific protective trade recommendations:

1. Reverse Dispersion: Go long on correlation. Specifically, sell single-stock volatility swaps on the top 50 constituents of the S&P 500 while going long on S&P 500 index volatility swaps, profiting from betting on rising correlation.
2. Three-month put options on IWM: Currently, the one-month 25-Delta put options on IWM are at the 48th and 46th percentiles over one-year and five-year lookbacks, respectively. The protection cost is reasonable, and it can serve as a hedge against rising interest rate risk.
3. Short-term option protection for GSXURFAV: Arrange short-term option positions for the basket of retail favorite stocks tracked by Goldman Sachs (GSXURFAV) to cope with potential volatility in these stocks after retail activity cools down.

Finally, the Goldman Sachs Portfolio Strategy Team summarized the historical performance patterns of the US stock market during midterm election years:

• Before the election: The stock market generally moves sideways, lacking direction;
• After the election until year-end: The stock market trends upward;
• Volatility: Begins to rise mildly in late summer and accelerates significantly in the month before the election.

In addition, mutual funds tend to hold higher cash levels before midterm elections and deploy concentratedly only after the election results are announced. Foreign investors follow a similar pattern, tending to moderately reduce their holdings of US stocks about one month before the election.

The team believes that this means limited incremental buying from mutual funds and foreign investors in the short term, but this does not constitute a major bearish factor for the stock market. The broader conclusion is that the stock market currently lacks upward "catalysts," while potential upside opportunities exist at year-end.

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