Goldman Sachs hedge fund head: Signs of capitulation among bulls in US stocks, the AI cycle seems to have entered a new phase of skepticism

Goldman Sachs partner and global head of the hedge fund tracking department Tony Pasquariello believes that the U.S. stock market has shown signs of a bullish "surrender," and the market seems to be entering a new phase of the artificial intelligence (AI) cycle, with investors beginning to question the sustainability of capital expenditures and future returns of large-scale cloud service providers.

Despite this, Pasquariello maintains his judgment that the main upward trend of U.S. stocks remains intact, expecting the S&P 500 index to close above current levels by the end of 2025, but has lowered his expectations for the stock market performance in the coming year.

This Thursday, U.S. stocks experienced a sharp drop during trading, with the S&P 500 index rising over 1.9% at its intraday high in the morning but ultimately closing down nearly 1.6%, erasing more than $2 trillion in market value from the day's peak and closing below the 100-day moving average for the first time in months. Although NVIDIA reported impressive earnings after the market closed on Wednesday, it failed to alleviate concerns about high valuations. The S&P 500 has accumulated a decline of about 4% since entering November, poised to record its worst November performance since 2008.

In a report to clients this Friday, Pasquariello noted that while lower prices may trigger more selling from systematic and active traders, and the "hangover" from October may not have fully dissipated, his intuition is that the market experienced significant risk transfer this week and showed some signs of capitulation.

However, the Federal Reserve's "third-in-command," New York Fed President John Williams, who holds permanent voting rights on the FOMC meetings, released dovish signals on Friday. He stated that as the labor market cools, the Fed still has room for further rate cuts in the near term. This statement fueled market bets on a rate cut in December, with the probability of a 25 basis point cut rising from about 30% at Thursday's close to 56%.

BMO Capital Markets' U.S. interest rate strategist Vail Hartman pointed out that Williams' comments are crucial, as he is one of the centrist voting members of the Fed's monetary policy committee FOMC, and his vote could ultimately determine the direction of the December rate decision. Previously, there was uncertainty about his stance on the outlook for the December meeting.

Signs of Bullish Surrender Emerge, Selling Pressure Not Fully Released

Goldman Sachs' trading department has observed gradual selling pressure for several weeks, but Thursday's sell-off was abrupt, with investors eager to lock in year-to-date gains. Pasquariello cited client conversations and market trends, stating that while the S&P 500 index is still up about 11% this year, the market is undergoing significant risk transfer.

Pasquariello noted that although NVIDIA reported "impressive earnings that exceeded expectations and raised guidance," the market seems to be entering a new phase of the AI cycle. Investors are beginning to question the sustainability of capital expenditures and future returns of large-scale cloud service providers.

Wall Street Insights previously mentioned that Goldman Sachs trader Rich Privorotsky further pointed out in a recent research report that the focus of the AI narrative has shifted to Google and the disruptive breakthroughs represented by its Gemini-3 model This "disruptive model" is reshaping the entire AI investment ecosystem, forcing other companies to delay their product cycles, increasing capital expenditure demands, and making investment returns more uncertain. The market is forming a clear pattern of "winners and losers," with the risk of a "winner-takes-all" dynamic emerging in the model field.

The Fed's Hawkish Stance Intensifies Policy Uncertainty

Employment data has further complicated market sentiment. Pasquariello stated that the three-month average job growth is "fairly decent," but the rise in the unemployment rate to 4.44% in September is still "concerning." He pointed out that recent hawkish comments from Federal Reserve officials have reignited policy uncertainty, with some officials indicating a reluctance to cut rates in December, "marking a shift from the smooth rate-cutting path we seemed to be on previously."

Rich Privorotsky emphasized in his review that the latest employment data presents conflicting signals: job growth appears robust, but the unemployment rate has unexpectedly risen. The increase in the unemployment rate is primarily due to a large influx of workers aged 16-24 into the market, but the three-month average of new jobs has only dropped to 62,000, and Goldman Sachs' internal employment tracking indicator shows potential new jobs at only 39,000. More concerning is the continued downward revision of employment data, with August's figures being particularly weak.

Against this backdrop, the Federal Reserve continues to maintain a hawkish tone, and market bets on a rate cut in December have been quickly withdrawn. Privorotsky bluntly stated, "Maintaining a hawkish stance in this employment context is a policy mistake."

Williams' Dovish Remarks Boost Market Confidence

On Friday, New York Fed President Williams stated that as the labor market cools, he believes there is still room for further rate cuts by the Federal Reserve in the near term to adjust the policy stance closer to neutral. In a speech delivered in Santiago, Chile, Williams noted that the downside risks to employment have increased, while the upside risks to inflation have eased. He believes that monetary policy is currently in a mildly tightening state, but the degree of restriction is lower than before recent actions.

Following Williams' remarks, traders increased their bets on a rate cut in December. The rates on overnight index swap contracts related to the December meeting of the Federal Reserve fell sharply, with the market pricing in about 14 basis points of easing, equivalent to a 56% probability of a 25 basis point rate cut, compared to just 8 basis points of easing expectations at Thursday's close. The market reacted positively, with the three major U.S. stock index futures rising sharply, U.S. Treasury bonds increasing, and spot gold rising nearly $10 in the short term.

Williams' comments are particularly noteworthy because, after the Federal Reserve's second consecutive rate cut in October, several officials expressed opposition or uncertainty regarding a third consecutive cut in December. Williams indicated that trade tariffs may have contributed about 0.5 to 0.75 percentage points to the current inflation rate, but he has not seen any secondary effects or other price spillover effects from the tariffs. He expects tariffs to continue pushing prices higher next year, but inflation will return to the 2% target trajectory by 2027.

Systemic Factors Amplify Market Volatility

Rich Privorotsky pointed out in his review that the current market turbulence stems from the cumulative effects of four major factors: the Federal Reserve's unexpected hawkish shift, the internal severe differentiation of logic within the AI sector, the flash crash in cryptocurrencies prompting retail investors to "abandon ship," and finally triggering concentrated selling pressure from quantitative funds, causing the market to slide from "technical turbulence" to "structural decline." The severe fluctuations in the cryptocurrency market have become a "barometer" for retail investors' risk appetite. Over the past two years, the behavior pattern of retail investors has been to buy without selling, buying more as prices drop. However, this time there has been a qualitative change: multiple large accounts have been continuously selling off, and retail investors are no longer "holding firm," but are actively cutting their positions. This panic sentiment is spreading to unprofitable tech stocks and AI-related stocks.

According to a Goldman Sachs report, trend-following funds have held over $500 billion in long positions since early August. Once the index falls below a key level, it will trigger continuous selling. As realized volatility rises, volatility control strategy funds have begun to sell off, causing the market's originally stable "low volatility structure" to collapse instantly. Systematic funds act like a machine, collectively selling off after being triggered by price movements.

Bullish stance unchanged, but expectations adjusted

Despite the increased market volatility, Pasquariello still believes the main trend of the stock market is upward. He stated that the U.S. economy is expected to accelerate growth, and liquidity conditions will also improve. Although the selling by systematic funds still needs to be digested, he anticipates that corporate buybacks and retail investors will step in to take over.

"This is a bull market, and the main upward trend remains intact," he wrote. He still expects the S&P 500 index to close above its current level by the end of 2025, but has adjusted his expectations for the stock market performance next year.

Goldman Sachs technical charts indicate that the S&P 500 mini futures may further dip to the 6,500-point level. However, Privorotsky believes that the fundamental value logic of AI technology has not changed, and the true long-term winners will be labor-intensive companies that achieve marginal profit expansion through automation. He believes that market stabilization requires three conditions: the clearing of trend-following fund positions, the squeezing out of excessive long positions by retail investors, and the stabilization of cryptocurrencies, along with clear dovish signals from the Federal Reserve or support for AI capital expenditures at the policy or market level