Goldman Sachs: Market Rotation Driven by Positioning, Not Fundamentals

The recent sharp rotation out of high-flying momentum stocks is likely a tactical reset driven by investor positioning rather than a fundamental change in market outlook, according to analysts at Goldman Sachs. The bank views the pullback as a consequence of profit-taking after a strong first half, with the upcoming earnings season poised to be a critical test of this thesis.

A Tactical Reversal

According to a note from the investment bank, the momentum trade has experienced one of its most severe reversals in recent history, with the momentum pair falling about 8% since June 22. Goldman Sachs attributes this to investors taking profits after a strong market run, combined with thinning liquidity heading into the summer, which made the market vulnerable.

The unwind has been particularly concentrated in the artificial intelligence sector. For example, Goldman highlighted that in Europe:

• European Semiconductors dropped 12% from their June peak but remain up approximately 110% year-to-date.
• In contrast, Software stocks rebounded about 5% over the same period but are still down 23% year-to-date.

Shifting Sector Dynamics

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Goldman Sachs noted that this year in Europe, sectors like Hardware, Basic Resources, and Industrials have been most positively correlated with the momentum factor. This aligns with the bank's "Capital Intensity" framework, which suggests that asset-heavy companies are benefiting from strong demand linked to rising capital expenditure. The bank's HALO (Heavy Assets, Low Obsolescence) strategy, which goes long on capital-intensive firms and short on capital-light ones, is up about 20% year-to-date.

Despite the broad pullback, some sectors have shown resilience. Aerospace & Defence has outperformed, supported by strong earnings momentum and geopolitical tensions. Healthcare has also held up, aided by attractive valuations and its defensive characteristics, according to the bank.

Earnings Season a Critical Test

Goldman Sachs identified the upcoming Q2 reporting season as the crucial test for its view. A strong earnings season would support the argument that the recent market action was primarily a positioning reset rather than the beginning of a new trend.

Consensus forecasts for Europe point to an 11% year-on-year EPS growth. However, excluding the volatile Commodity Producers sector, that growth forecast is a more modest 6%. The results will be closely watched for confirmation of underlying corporate health.