Goldman Sachs' head of global hedge fund client business, Tony Pasquarello, has indicated that the US stock market could face a tougher period after Labor Day in early September, but robust corporate earnings and favorable technical conditions should sustain the broader bull market.

In a client note dated August 7, Pasquarello highlighted that the S&P 500's breakout from a months-long consolidation range has reinforced his bullish stance on equities. He anticipates market pressure in September due to increased supply and unfavorable seasonal factors, but believes these elements will not derail the overall upward trend. His core thesis is that "both the fundamental backdrop and technicals support the continuation of the bull trend on a wider scale."

Investors Hold Long Positions, But Positioning Has Improved

Pasquarello noted that client communications and Goldman's trading activity indicate investors still maintain net long positions, though positions are now less crowded than at the end of the second quarter. He stated that a "significant risk transfer" in July has left the market more balanced entering August. This clearer positioning may help explain the renewed demand for stocks as the market has rallied. The skew of short-term S&P 500 options fell sharply last week due to strong demand for upside exposure. Options skew refers to the difference in implied volatility (and pricing) between comparable put and call options. Pasquarello noted that S&P 500 call option volume hit a record high last Tuesday. He pointed out that fast-moving investors had reduced positions in early August but are now buying back in as the market rises.

Earnings Remain the Foundation of the Bull Case

Corporate profits are among Pasquarello's strongest arguments for staying bullish. The S&P 500 has experienced seven consecutive quarters of exceptional earnings growth. Excluding private companies, first and second quarter earnings grew an average of 25% year-over-year. Goldman's US portfolio strategy team expects earnings to still achieve double-digit growth next year. Pasquarello stated, "History books are very clear: challenging such powerful earnings power is a recipe for disappointment."

The question arises whether investors will be disappointed when earnings growth inevitably slows. Goldman strategist Ben Snyder expects corporate earnings growth to decelerate next year, driven by reduced fiscal stimulus and slower growth in AI capital expenditure. The report noted that AI capex currently accounts for about half of S&P 500 earnings growth. As these investments scale up and become increasingly reliant on external financing, maintaining the same growth rate will become more difficult. Despite this, Pasquarello sees reasons for optimism. Historically, slowing earnings growth that remains positive tends to change the composition of market-leading sectors rather than the overall direction. Additionally, consensus expectations already factor in some deceleration, leaving room for earnings beats, as demonstrated in the second-quarter earnings season.

Nvidia Returns to the Spotlight

Pasquarello also highlighted Nvidia (NVDA.US), calling it a bellwether stock for the current market environment. He noted that Nvidia has received surprisingly little attention recently, including in investor conversations. However, the stock has quietly rebounded 18% from its low a week earlier. Reports indicate that Nvidia announced a series of major partnerships at the San Francisco AI Summit in late July, including a deal with SK Group exceeding $500 billion, an investment in Naver, and deepening its AI ecosystem collaboration. Nvidia is scheduled to report earnings on August 26, coinciding with the Federal Reserve's Jackson Hole Symposium. Pasquarello suggested that market liquidity may deteriorate around these events. These factors combined could make late August an important test for the market rally.

Rebuilding Gold Positions

Pasquarello also noted a resurgence of interest in gold after it posted its largest single-day gain in six months last Wednesday. The options market is skewed toward call options, and gold prices have reclaimed their 50-day moving average. Goldman senior trader Tony Kim estimates that current gold positioning among traders is at a 3, compared to a highly bullish 10 in January. Gold positions have risen modestly over the past two weeks. Kim attributed this change partly to expectations that the Federal Reserve's tightening cycle may be pushed further out and rising hopes for a resolution regarding the situation in the Strait of Hormuz. Kim stated that central bank buying provides a floor for gold prices near $4,000, while Chinese speculators have recently returned to the market. Increased volatility and gold's diminished correlation with real rates and forex markets have also boosted confidence in this move. Kim said the main threat to this outlook is a renewed conflict between the US and Iran, which could disrupt energy transport and push oil prices back above $100 per barrel.

Hedge Funds Reduce Momentum Stock Exposure

Pasquarello stated that both systematic and fundamental long-short hedge funds have significantly reduced their exposure to momentum stocks. Systematic funds still hold significant momentum exposure, but their leverage has declined sharply from recent highs. Fundamental long-short funds have also trimmed their momentum exposure after it surged earlier this year. Positioning data further confirms Pasquarello's broader assessment that investors are entering the next phase of the rally with less crowded positions than earlier this year. Pasquarello warned that this does not guarantee a sustained uptrend. Supply-demand factors and seasonal patterns could lead to some "volatility" in the market after Labor Day. However, given that corporate earnings are still growing rapidly and positions are more balanced, Pasquarello views these risks as temporary fluctuations within a bull market rather than signs of its end.