Goldman’s Flood Anticipates Possibility of a ‘Dramatic’ Surge in Equities

Hedge Fund Strategies Set Stage for Potential Stock Rally

According to Goldman Sachs' trading team, the current positioning of hedge funds in US equities could pave the way for a significant rebound in stock prices following recent volatility.

While many speculative investors have maintained optimistic stances on individual stocks, they have simultaneously increased their defensive positions by shorting exchange-traded funds and index futures. Data from Goldman’s prime brokerage indicates that this level of short exposure is the highest since September 2022.

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This trend highlights the market’s struggle with ongoing uncertainty, driven by the conflict in Iran, credit concerns, and questions about artificial intelligence. John Flood, who leads Goldman’s Americas equities execution services, notes that if positive developments prompt investors to close out their hedges, the resulting rally could be substantial.

Flood explained, “A headline announcing the end of the conflict could spark a rapid surge in the indexes, possibly jumping 2% to 3% almost instantly, mainly due to covering of macro hedges.”

Hedge Fund Exposure Near Record Levels

Goldman Sachs reports that hedge funds’ gross exposure—which combines both long and short positions—has climbed to nearly 307%, approaching historic highs.

Flood added, “Currently, the risk of a sharp upward move outweighs the risk of a steep decline. With such elevated gross exposure and significant shorting of broad market products, any encouraging news could trigger a wave of short covering.”

This scenario played out recently when President Donald Trump suggested that the Iran conflict could soon be resolved. The S&P 500, after dropping 1.5% earlier in the day, ended up 0.8% higher as traders rushed to buy back previously shorted securities. Despite this, the index is still about 3% below its peak, and many individual stocks have seen even steeper declines.

Market in a Holding Pattern

The turbulent environment has already impacted investors, with fundamental long-short hedge funds losing roughly 4% of their year-to-date gains last week due to sharp sector rotations, according to Goldman.

Other hedge fund categories have yet to make significant adjustments. Flood notes that long-only asset managers, such as traditional fund managers and sovereign wealth funds, are largely waiting for clearer signals before making moves.

Investor Sentiment and Corporate Buybacks

Flood observed, “Long-only investors performed well earlier this year, but since the conflict began, many have adopted a wait-and-see approach due to heightened uncertainty and volatility.”

Corporate share repurchases have also provided a cushion for the market. Goldman’s buyback desk recently experienced one of its busiest weeks for stock buybacks in the past three years.

Retail investors continue to play a key role in supporting stocks, but their enthusiasm could wane if the job market deteriorates significantly. Flood cautioned, “A series of disappointing jobs reports could cause retail demand to dry up and trigger a market selloff, though we don’t see that happening based on the latest data.”

Liquidity Challenges and Volatility Risks

Flood warns that thinning liquidity is likely to make stocks more volatile in the coming weeks. Although trading volumes have exceeded 20 billion shares daily this year, the depth of liquidity—reflecting the ability to execute large trades without moving prices—has dropped sharply.

Goldman estimates that the amount of S&P 500 futures available at the best price, known as top-of-book depth, is now around $4 million, well below the historical average of $14 million. Levels under $7 million typically indicate market stress.

“This means that large institutional trades have a much greater impact on prices than usual,” Flood explained.

The direction of these price swings will likely depend on how the geopolitical situation unfolds. For now, investors are hoping that the uncertainty caused by the conflict will be resolved soon.

Flood concluded, “The market is anticipating some sign of resolution within the next two weeks. If the situation drags on without progress, it could pose problems for equities at the index level.”

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