Summary
- The stock market witnessed a strong upside-down pattern in July.
- It was driven by a junk rally and a surge in meme stocks.
- Fueling the junk rally were short squeezes and elevated retail investor sentiment.
- While near-term gains may continue, the risk of a medium-term drawdown has increased.
As we close out the month of July, an extraordinary pattern emerges in the stock market: everything has turned upside down. In this piece, we share our observations and break down what it means for investors.
What We See In Data
High Beta Stocks Soared
The first thing we noticed was the Low Beta index starting to nosedive.
While we've seen frequent such episodes since 2022, the current one is both steeper and faster.
Losers Turn Into Leaders
Momentum Flipped. The bigger the prior loser, the stronger the rebound in July.
The chart below shows that stocks in the bottom 5% of returns over the prior six months have gained 9.5% in the 30 days ending July 25.
Note: the S&P 1500 universe; author's calculation.
It's Not Just Momentum
Other factors have reversed too.
Small-cap value, long neglected, has suddenly emerged as a favorite.
Note: based on SPYG, SPYV, MDYG, MDYV, SLYG,SLYV; author's calculation.
Stock Selection Signals Flip
Stocks with solid fundamentals and earnings outlook greatly underperformed in July.
Those typically favored during risk-on periods following a market crash are leading the pack.
Note: based on three of our proprietary stock selection signals leaning toward
fundamental, earnings and risk-on phase, respectively.
Full-Throttle Risk-On
Our proprietary active signal has called for a 100% allocation to high-risk stocks since late June.
Note: proprietary active allocation signals;
when at 100% - calling for full allocation in high risk stocks; when at 0% - calling for zero allocation in high risk stocks;
risk is measured by a set of factors including but not limited to beta, quality and technicals.
What’s Driving These Market Moves?
A Junk Rally
The rise in Goldman Sachs' Speculative Trading Indicator has been one of sharpest increases on record.
The Meme Run
Every component of Goldman’s Speculative Trading Indicator is elevated relative to history.
Penny stocks and stocks with extreme valuation multiples are in the 95th percentile, while unprofitable stocks sit at the 85th percentile.
What’s Fueling Speculative Trading?
Retail Sentiment
There's a close relationship between Goldman Sachs' Speculative Trading Indicator and the performance of a basket of stocks popular with retail traders. The Retail Favorites basket has surged 50% since early April, boosted by social media sentiment.
Short Squeeze
July experienced one of the sharpest short squeeze on record.
Since early April, Goldman’s Most Short basket has surged over 60%, outperforming the equal-weighted S&P 500 by nearly 40 percentage points.
Where Do We Go From Here?
Low Breadth Often Sets the Stage for More Rotation
Despite that the broad stock market is making record highs,
the market breadth is extremely narrow now.
Historically, concentrated leadership is often the catalyst for broader, sustained rotation.
Call Option Activity Reaches Heated Levels
Call options now make up 61% of total option volume, the highest since 2021,
indicating increased risk appetite in the stock market.
Above-Average Short-Term Gains Likely Ahead?
Historically, sharp increases in speculative trading have signaled above-average near-term equity returns, but often at the cost of a higher risk of medium-term drawdowns.
