AI Faith vs. Recession Alarm: The Bull-Bear Battle in U.S. Stocks Enters a Critical Period

The U.S. economy is signaling weakness, and investors are weighing the tension between the AI boom and deteriorating economic fundamentals, facing a difficult choice.

Bloomberg strategist Jan-Patrick Barnert pointed out in a recent article that bulls in the U.S. stock market are questioning whether the excitement around AI is enough to support overall market performance, especially against the backdrop of tariff pressures, inflation erosion, and a cooling labor market. The article cited Goldman Sachs partner Richard Privorotsky's analysis:

Tariffs are essentially a form of taxation, inflation has eroded real income, the economy is in the late cycle, and the U.S. labor market continues to be in a state of "no layoffs, but also no hiring."

As market breadth narrows and the weight of tech stocks reaches an all-time high, investors are looking for effective hedging strategies. According to a Goldman Sachs report, its cyclical versus defensive stock comparison indicator has reached historical highs twice this year. Nomura believes that the seemingly balanced market structure can easily lose balance once a sustained pullback occurs.

On one side is AI enthusiasm, on the other side is recession panic, leaving investors in a dilemma

Barnert believes that the sustained rebound in U.S. stocks in July was largely due to the market's optimistic expectations for AI, which successfully prevented any significant market corrections. Large tech stocks once again dominated the performance of benchmark indices, and the weight of the tech sector has reached an all-time high after adjustments. Although there is some validity to predictions about how AI will drive global economic development, the crowded nature of this trade has narrowed market breadth and increased potential risks.

Meanwhile, the impact of tariff policies is beginning to show. Goldman Sachs analysis pointed out that "tariffs are essentially a form of taxation," coupled with inflation eroding real income, posing challenges to U.S. economic growth. Ed Yardeni of Yardeni Research believes that early bargain hunters in the market seem to believe that "if the economy is indeed weakening, the Federal Reserve will lower the federal funds rate, bond yields will continue to decline, thereby avoiding recession and reviving growth."

In the current market environment, the difficulty for investors seeking hedging strategies is unprecedented. They must decide whether they are prepared to short major U.S. benchmark indices, which carry significant holding risks. Once the AI boom overwhelms the sluggish economic fundamentals at the index level, short sellers may face severe short squeezes.

This is also why some traders prefer to return to a more classic strategy of comparing cyclical stocks to defensive stocks as a better tool to cope with economic slowdown. According to a Goldman Sachs report, its cyclical versus defensive stock comparison indicator has reached historical highs twice this year, reflecting that the market is still pricing in economic growth, while valuations have returned to the highs seen before April.

Goldman Sachs traders wrote in a client report:

Given the current macro environment, this portfolio may face a pullback of 14-21 percentage points

Short-term Market Outlook Remains Uncertain

Recently, the capital flow of systematic traders has also been an important factor affecting the market. CTA (Commodity Trading Advisor) strategies have expanded significantly and require more upward momentum and volatility compression to increase exposure, while the downside trigger point for European benchmark indices is closer than that of the S&P 500.

According to Nomura's Charlie McElligott, the latest market volatility may trigger some pressure on volatility control funds, although the extent is limited. Meanwhile, as the U.S. earnings season approaches its end, increased corporate buybacks provide some support. However, the seemingly balanced market structure can easily lose equilibrium once a sustained pullback occurs.

This week, the market's failure to show sustained selling supports the view of limited downside pressure. McElligott stated:

We only need to see a decline lasting more than a day to witness further liquidation in the spot market and 'punish short volatility supply,' especially against the backdrop of a slight sell-off just one day after hitting a historic high last Thursday.

Currently, this may just be a "random" profit-taking on a low participation, slow-paced summer Friday.

Market participants are closely monitoring more economic data to determine whether the current volatility is merely a short-term adjustment or the beginning of a deeper economic slowdown