BTIG strategist Jonathan Krinsky pointed out that hedge funds have increased their total leverage and decreased their net leverage, highlighting the contradiction of "increasing exposure without increasing direction," warning that "something must give."

Written by: Dong Jing, Wall Street Insights

Under the surface calm, U.S. stocks are undergoing a structural tear.

Goldman Sachs' derivatives trading head Brian Garrett warned that the U.S. stock market "refuses to price in any panic." The Goldman Sachs Panic Index closed below 1 last Friday, with the VIX remaining in the low teens, but at the same time, the bond volatility index, the MOVE index, is at an extreme high around the 100th percentile—this divergence is sending a rare structural warning signal to the market.

Even more concerning is the collapse of breadth within the U.S. stock market. Among the S&P 500 constituents, the proportion standing above the 200-day moving average is less than 50%; the number of stocks hitting 52-week lows has outnumbered those hitting new highs for nine consecutive trading days—this simultaneous triggering of both indicators is the first occurrence since the peak of the internet bubble in 2000. Meanwhile, the median stock in the S&P 500 has fallen 16% from its 52-week high, while the overall index remains near highs due to the strength of AI-related leaders, creating a severe "index obesity" pattern.

Hedge fund behavior also confirms this split: according to Goldman Sachs' latest Prime data, U.S. long-short funds' total leverage rose to 210.6% (the 42nd percentile for the year), while net leverage dropped to 48.6% (the 5th percentile for the year)— institutions are increasing their positions while significantly hedging, reflecting a highly contradictory mindset of "increasing exposure but not directional bets."

AI Holds Up the Facade, Most Stocks Are in a "Bear Market"

Goldman Sachs partner and head of execution services for Americas equities, John Flood, pointed out that the strength of the AI sector is masking the widespread deterioration inside the U.S. stock market. The median stock in the S&P 500 has fallen 16% from its 52-week high, while the index itself remains near historic highs, dragging market breadth down to the lowest level since the internet bubble.

Specific data shows that about 70% of S&P 500 constituents are currently trading below the 50-day moving average, and the proportion of constituents above the 200-day moving average has fallen below the critical threshold of 50%. The AAII bearish ratio among retail investors is nearing 50%, indicating that market sentiment is in a clearly pessimistic range.

Goldman Sachs' U.S. equity investor sentiment indicator has dropped to -0.9, matching the reading at the market's temporary low in March of this year.

However, this pessimism has not translated into volatility pricing. Garrett explicitly stated that the stock market "refuses to price in any panic"—the Goldman Sachs Panic Index closed below 1, and the implied volatility of individual stocks has not effectively reset to higher levels after the sell-off at the end of July.

Extreme Divergence Between VIX and MOVE: The Bond Market Is "Screaming"

The most prominent structural anomaly in the current market is the extreme divergence between stock volatility and bond volatility.

Garrett pointed out that the MOVE index (which tracks volatility in the U.S. bond market) is currently at a historically extreme level around the 100th percentile, and the credit default swap index (CDX) is also in the "peak panic" zone; meanwhile, the VIX is still trading in the low teens. The bond and credit markets are pricing for tail risks, while the stock market remains calm.

From the details of the credit market, Goldman Sachs investment grade credit analyst Brad Shelofsky noted that the total return yield on investment-grade bonds has risen to a multi-year high, making yields themselves attractive; however, the spread's proportion of the total return is low, making it difficult to generate strong bullish sentiment at a spread level of +80 basis points. The rapid rise in interest rates will suppress demand and raise concerns about capital outflow—despite recording a net inflow of $1.8 billion last week, the overall market sentiment remains low.

Additionally, CCC-rated credit spreads have widened for 11 out of the past 14 trading days and are nearing 2022 levels; the CDS spreads for investment-grade technology have also expanded to their widest since 2023. Garrett stated that this dynamic "may truly scare investors during the summer, and whether it will play out again remains to be seen."

The Ghost of 2000: Historical Precedents and Potential Risks

BTIG's chief technical market strategist Jonathan Krinsky further noted that the simultaneous triggering of the two breadth indicators is a combination not seen since 2000.

Since 1990, there have only been 25 trading days in which "less than 50% of S&P 500 constituents stood above the 200-day moving average, while the index itself was near a 52-week high," with all 25 days concentrated between 1998 and 2000. The situation in 1998 occurred after a significant -22% pullback and was not a top signal; however, the readings from late 1999 to early 2000 are more alarming—this was around the peak of the internet bubble.

Historical analysis shows that from July 1999 to February 2000, the equal-weighted S&P 500 fell about 16%, while the market-cap-weighted S&P 500 rose about 8%; afterward, the roles of the two switched, with the S&P 500 falling 17% later that year, while the equal-weighted index rebounded 20% during the same period. The core question raised by Krinsky is:

This time, will the breadth and equal-weight indices stabilize before the market cap index, followed by a downturn in the market cap index?

Krinsky also pointed out that there have been 213 consecutive trading days without a single day on the NYSE where the volume of declining stocks exceeded 80%—a "high correlation sell-off day." Historically, there are an average of 21 such trading days per calendar year, with no less than 5 days in any given year. He believes that continuous sector rotation, while preventing correlation from rising to a concentrated sell-off, is "time is still ticking."

Hedge Funds: Increased Leverage but Not Direction, Contradictory Signals Concentrated

The positioning structure of hedge funds is the most direct reflection of the current contradictory sentiment in the market.

According to the latest data from Goldman Sachs Prime, U.S. long-short funds' total leverage rose by 1.2 percentage points to 210.6% (the 42nd percentile for the year) last week, while net leverage fell by 1.2 percentage points to 48.6% (the 5th percentile for the year). The increase in total leverage means institutions are increasing market exposure, while the decrease in net leverage indicates that both long and short positions are expanding without increasing directional bets.

Garrett summarized this phenomenon as:

"Total leverage is rising, while net leverage is relatively controlled—institutions are increasing exposure, but not increasing directional conviction."

The U.S. fundamental long-short ratio (based on market capitalization) has fallen by 1.5% to 1.601 during the same period, sitting at the 3rd percentile for the year, further confirming institutions' heightened caution regarding direction.

Garrett pointed out that on market rebound days, one can "feel" the market's underweight positioning—when the Nasdaq 100 index hit a historical high last Monday, the implied volatility of call options significantly outperformed, indicating active buying of upward options, but considering the holding costs, these options are not "expensive." He believes this pattern is driving "chasing" behaviors at the individual stock level and may spread to the index level.

Three Scenarios: Good, Mediocre, or Ugly?

In light of the above signals, Goldman Sachs' internal and market strategists have provided three distinctly divergent scenario judgments.

In the optimistic scenario, Flood believes that the current extreme pessimism and underweight positioning itself constitutes a potential upside catalyst. He states that "these factors collectively point to the potential for an overall uptrend in the market and a 'catch-up' in recently lagging stocks, should macro uncertainty not exacerbate further."

In the neutral scenario, Garrett believes "the current positioning structure of the market is suited for a risk-on fluctuation," but admits that "despite everyone watching the same risks, there is hardly anything that can genuinely crush the U.S. stock index." He lists potential catalysts before the end of the year as the midterm elections, tech earnings, or easing tensions in the Middle East, concluding with a popular market saying: "The market will never give you a 'full safety' signal without making you pay the cost of missing out."

In the pessimistic scenario, Krinsky's conclusion is the most direct: "Something's gotta give." He believes that if the situation in Iran eases, the hardest-hit sectors (consumer discretionary, finance, REITs, utilities) will rebound first, while tech and AI sectors may lag; however, if a high-correlation sell-off day eventually comes, the current breadth deterioration will serve as a leading indicator for a larger-scale adjustment.