Goldman Sachs: Monday will be a painful day for short sellers, the surge in digital currencies is just the beginning

Since the beginning of the year, global asset markets have experienced a rollercoaster ride. Although February started strong with various assets reaching new highs, the end of the month saw a dramatic turn of events. Gold, Bitcoin, and U.S. tech stocks all retreated from their peaks, and the yield on the 10-year U.S. Treasury bond also fell significantly.

According to Goldman Sachs traders, behind this extreme volatility lies the brewing of a new market storm — Monday's U.S. stock market may see a severe short squeeze:

"Monday will be a painful short squeeze day, as risk assets could surge significantly, not just because of weekend crypto news."

Last week, the S&P 500 index and the Nasdaq 100 index fell by 0.98% and 3.38%, respectively, but as Goldman Sachs' top trader John Flood pointed out, the actual sentiment is worse than the data suggests. Goldman Sachs' "Meme stock basket" fell another 6.79% last week after a 10.05% drop the previous week; the long momentum stock basket declined 4.03% last week after an 8.58% drop the week before.

However, Flood emphasized that the market showed positive signals at the close on Friday, February 28. At the end of February, pension funds needed to buy about $13 billion in stocks (while selling $13 billion in U.S. Treasuries) to rebalance, which helped absorb about $20 billion in S&P 500 selling from CTAs (Commodity Trading Advisors), particularly evident in the last 10 minutes of trading on Friday.

After a massive short position by hedge funds, market momentum indicators have dropped to their lowest levels in a decade, which is often a precursor to a reversal. At the same time, several positive factors are accumulating that could catalyze a sudden market surge, catching short investors off guard.

Massive Short Selling by Hedge Funds Sets Recent Records

Data shows that last week, the total leverage ratio of U.S. long-short hedge funds fell by 1 percentage point to 206.5% (the 98th percentile over the past three years), and the net leverage ratio dropped by 3 percentage points to 53.5% (the 55th percentile over the past three years), marking the largest weekly decline since September 2023.

Goldman Sachs noted that more notably, U.S. long-short fund managers just experienced their worst 7 days since October 2022 (down 2.84%), with only a 0.98% increase year-to-date. The nominal short selling volume in the U.S. market last week (heavily concentrated in macro products) was the second largest in the past five years (almost on par with September 2022), placing it in the 100th percentile.

This high-intensity short-selling behavior has kept the overall market leverage unexpectedly high.

Goldman Sachs macro trader Paolo Schivaone believes that unless there is conclusive evidence indicating that the trend of U.S. stocks is about to reverse, the short squeeze will continue to dominate the market. He emphasized that the 5-day momentum return rate is currently at the 3rd percentile of the past 10 years, which means that momentum strategies (MOMO) will provide very substantial returns in the current environment.

Combining several positive news over the weekend, Schivaone expects that risk assets may experience a sharp rise on Monday, triggering a painful short squeeze:

1. Geopolitical easing: The possible restart of "Nord Stream 2" may lead to a decline in European natural gas prices, benefiting risk assets.
2. Cooling trade frictions: The U.S. hinted that tariffs on Mexico and Canada may be lower than 25%. This could trigger a rebound in emerging market risk assets.
3. German fiscal stimulus: The new German government quickly established two special funds of €400 billion each for defense and infrastructure construction.
4. Bessent's interview: U.S. Treasury Secretary Bessent emphasized in an interview over the weekend that controlling the yield on 10-year Treasury bonds to reduce inflation is the path to achieving this goal.

Additionally, Bitcoin has risen 20% since last Friday's low, further boosting market risk appetite.

Market "Pain Points": Chasing Beta, Squeezing Shorts

Overall, the market is at a delicate balance point. On one hand, short positions are high, momentum indicators are reversing, and both technical and news factors point towards a short squeeze; on the other hand, macroeconomic data is mixed, with uncertainties still surrounding inflation and employment data.

As legendary trader Jesse Livermore said:

"Big money is not made by individual fluctuations, but by grasping the main trend, not by interpreting the market, but by assessing the entire market and its trends."

In the view of Goldman Sachs traders, the market will seek the maximum "pain point," chasing Beta and squeezing U.S. stock shorts. Investors need to closely monitor market sentiment and position changes, being wary of potential short squeeze risks