Stock Market Rotation: From AI to Regional Banks - Goldman Sachs Advises Hedging Momentum

Goldman: Time to hedge momentum as rotation continues By Investing.com

Momentum refers to the concept that suggests "what worked yesterday will continue to work tomorrow," and the recent market rotation might indicate a shift in the prevailing conditions, according to analysts at Goldman Sachs (NYSE:GS). Momentum has thrived so far in an environment marked by higher interest rates and has become closely linked with dominant secular themes. "Two soft CPI prints in a row and the possibility of a July rate cut suggest we could still be on track for a soft landing, and the lower quality, risk-on assets part of the short leg of momentum may continue to outperform," analysts said in a note. However, the question remains whether the strategies that have worked over the past six months will continue to be effective as rate cuts are repriced, political regime change probabilities rise, and AI valuations are reassessed. "We think it could make sense to take profit on momentum gains given the change in the market dynamics as the rotation we pointed out last week continues," they added. Although AI valuations appear stretched, earnings reports are not imminent, and with no short-term catalysts, there might be potential for a short-term pullback, coinciding with underperformance in the size factor. Momentum experienced its best year on record, driven by the outperformance of the long leg - AI and secular themes - and the underperformance of the short leg amid higher rates. U.S. equities fell sharply on Wednesday as declining microchip stocks, amid potential escalations in U.S.-China trade conflicts, amplified the ongoing rotation out of mega-cap tech stocks. A report indicating that the Biden administration is considering strict trade restrictions against China led to a 6.8% drop in microchip stocks, marking the Philadelphia SE Semiconductor index's largest one-day decline since March 2020.

Goodbye AI, hello regionals: The stock theme rotation in one chart (NYSEARCA:SPY)

Investors should be hedging momentum as the rotation in equities gains traction, according to the Goldman Sachs trading desk. The global chip selloff Wednesday led to the Nasdaq's (COMP.IND) worst session since 2022, but the more-AI-insulated Dow (DJI) topped 41,000. "Is what has worked the last 6 months still going to work when rate cuts are repriced, political regime change probabilities are increasing, and AI has re-rated?" Goldman's FICC & Equities desk asked. "We think it could make sense to take profit on momentum gains given the change in the market dynamics as the rotation we pointed out last week continues, illustrated by the worst 5 day streak of Large Caps (NYSEARCA:SPY) (IVV) (VOO) over Small Caps (NYSEARCA:IWM) since 2020." The desk provided this chart of rotation in the last five days compared to where the money had gone through July 9.