After U.S. stocks recovered on Friday and nearly erased sharp losses suffered midweek, markets are facing an additional sell-off this week led by trend-tracking algorithmic funds, according to Goldman Sachs' trading desk.
The S&P 500 had already broken through the short-term stimulus level that prompts commodity trading advisors to sell stocks. Goldman Sachs expects these systematic strategies, which follow market direction rather than fundamentals, to remain net sellers this week, regardless of market direction.
According to the bank's estimates, a renewed sell-off could trigger approximately $33 billion this week. If the pressure persists and the S&P 500 falls below 6,707 points, it could open the door to up to $80 billion in additional systematic selling over the next month, the bank's data indicates.
If the market moves sideways, the funds are expected to sell about $15.4 billion of US stocks this week, and even if stocks rise, these funds are likely to get rid of about $8.7 billion.
The panic index is nearing critical levels.
Tension among investors was high last week. Goldman's panic index, which combines the implied volatility of the one-month S&P 500, the volatility of the VIX, the skewness of buy and sell prices, and the volatility structure curve, reached 9.22 points, a level that suggests markets were not far from a state of extreme panic on Thursday.
The S&P 500 jumped 2% on Friday, capping a volatile week with its biggest gain since May. This surge followed a sharp drop earlier in the week for both the S&P 500 and the Nasdaq 100, after the launch of a new AI automation tool from Anthropic wiped billions of dollars off the value of software, financial services, and asset management stocks, as investors reassessed the risks of technological disruption.
Low liquidity and positioning that increases volatility
The question of where to place systematic strategies was the most common question among Goldman clients on Friday, reflecting the growing demand to understand liquidity flows in the markets.
In addition to the sell-off of trend-following funds, weak liquidity and short gamma positions are expected to keep the market volatile, with the potential for upward or downward moves to be amplified, as traders are forced to buy on rises and sell on falls to balance their positions.
The liquidity of the S&P index, i.e. the volume of buy and sell orders available at the best bid and lowest ask prices, deteriorated sharply, falling to about $4.1 million, compared to an average since the beginning of the year of about $13.7 million.
In a note to clients on Friday, Goldman Sachs' trading desk team, including Gail Haviv and Lee Coopersmith, wrote: The inability to transfer risk quickly leads to more volatile daily movement and delays the stabilization of the overall price trend.
The positions of options traders have also shifted in a way that could intensify price movements. After being in a long gamma range that helped prevent a break below the 7,000-point level, traders are now estimated to have moved into a neutral to short gamma range, a dynamic that is exacerbated when liquidity is tight. The team added: Be prepared.
Other strategies may increase the pressure.
Other groups of systematic strategies still have considerable room to reduce risk. Risk-balancing strategies are positioned at the 81st percentile compared to last year, while volatility-control strategies are at the 71st percentile.
Unlike trend-following funds, these funds respond to ongoing changes in realized volatility, meaning their impact will be more pronounced if volatility remains high. While realized volatility for the S&P 500 has begun to rise, the 20-day metric remains below the levels seen in November and December.
February: A seasonal factor and changing individual behavior
Seasonal factors are not providing much support. February is historically the weakest and most volatile month for both the S&P 500 and Nasdaq 100, with the supportive flows of January, including retirement contributions and peak individual activity, fading away.
The behavior of individual investors also shows signs of exhaustion. After a year of continuous buying on every dip, the latest net imbalance in individual trading over two days showed sales of approximately $690 million last week, reflecting a waning appetite for buying on every dip.
Common individual trades involving cryptocurrencies and their stocks have come under particularly strong pressure, raising the risk that any broader shift away from US stocks could represent a significant departure from trading patterns in the past year.
