Momentum stocks plummet! Goldman Sachs traders: The "hottest stocks" in the U.S. stock market face the "largest sell-off"

The momentum stocks that have led the rise of U.S. stocks this year are currently facing a severe sell-off.

According to a report sent to clients by Goldman Sachs' top trader Guillaume Soria after Wednesday's market close, although the S&P 500 index closed nearly flat that day, there are undercurrents within the market. The market is experiencing a "strong liquidation" of recent mainstream investment themes, with momentum stocks that have performed well in the past facing widespread selling.

This sell-off has particularly impacted the most speculative sectors in the market, including heavily shorted stocks, quantum computing concept stocks, and unprofitable tech companies. The report warns that given the seasonal pattern of the momentum factor generally performing poorly from November to January in previous years, along with the currently crowded positions, this downward trend may not yet be over.

Momentum Trading Retreats, Funds Flow to "Quality Stocks"

Goldman Sachs traders have pointed out that a significant rotation is occurring in the market. There has been a noticeable outflow of funds from momentum stock portfolios based on performance over the past 3 months, 6 months, or 12 months.

Guillaume Soria emphasized in the report that the core theme of recent market narratives is being dismantled.

Data shows that previously high-flying speculative assets are leading the market decline, while the "quality stock" factor, which represents robust fundamentals, is regaining investor favor. This indicates that amid rising market uncertainty, investors are shifting from chasing high growth to seeking certainty in fundamentals, with a clear change in risk appetite.

Seasonal Headwinds and High Positions Intensify Sell-off Risks

The selling pressure faced by momentum stocks may have only just begun. Analysis by Guillaume Soria shows that historically, November to January is the worst-performing three months for the momentum factor. This seasonal headwind is particularly dangerous for momentum trading this year.

According to Goldman Sachs data, the momentum factor itself has risen about 7% this year, while the momentum stock basket constructed by Goldman has increased between 15% and 35%, with its strong performance primarily attributed to long positions. As investors lock in profits before the year-end, these stocks with significant gains are most likely to be targets for profit-taking.

Additionally, data from Goldman Sachs' prime brokerage business shows that hedge funds' exposure to momentum stocks remains at extremely high levels, ranking in the 90th and 94th percentiles over the past year and five years, respectively. Such crowded positions, once they begin to liquidate, can easily trigger a stampede sell-off

Momentum Stock Composition: Concentrated Exposure to High Beta and Technology Stocks

The current composition of momentum stocks makes them particularly vulnerable when the market shifts. Guillaume Soria found that the current momentum factor primarily goes long on information technology and industrial sectors while shorting healthcare and consumer sectors. Stylistically, it is heavily biased towards high beta and high volatility stocks, which have been strong performers since the April lows.

The report also mentions that since the "Tariff Liberation Day," the movements of momentum stocks and gold have been highly correlated, with both experiencing sharp declines in recent days. This correlation suggests that the macro factors driving these two asset classes may be changing.

The sharp drop in momentum stocks also reflects a lack of market breadth. Guillaume Soria pointed out that in 13 of the past 15 years, the S&P 500 index has outperformed the "X7 Index," which excludes the seven major tech giants. Since January 1, 2020, the annualized performance difference between the two has reached 6%.

Based on this, Guillaume Soria suggests that investors seeking tactical hedges may consider using the "X7 Index" to construct a limited loss hedging strategy. He believes this strategy is more cost-effective and targeted compared to directly hedging the S&P 500 index