"Nothing Short Of Overwhelming": Goldman's Hedge Fund Honcho Lays Out 'A Directional Framework' For Markets

In three short lines, Goldman's head of hedge fund coverage, Tony Pasuquariello, lays out in his latest note, a directional framework for markets:

i. it’s a bull market, and the primary trend is higher, but S&P is a different asset today than it was in recent few years.

ii. why I say that: growth is strong, financial conditions are easy and earnings are great, yet the setup for tech has changed.

iii. so, as S&P bides its time around the 6900 level, there are other rides to go on -- both within and outside the US. 

What's behind his thinking?

I continue to marvel at the muscle and the earnings power of US Mega-Cap Tech companies. 

I don’t really worry, in aggregate, about their balance sheets.  with that said, I have to acknowledge an inconvenient truth: the $667bn of hyperscaler capex that’s expected in 2026 would consume over 90% of operating cash flow; as illustrated in a chart last week, that’s a level we haven’t seen since the height of tech bubble. 

At the very least, this has clear implications for stock buybacks, which were already down 15% last year (it’s unclear whether that slowdown is temporary or more lasting). 

Said another way: the names at top of S&P are still generating huge amounts of capital, but they’re returning much less of it to shareholders (from 43% three years ago to 16% today). 

So, the very tidy balance of capital generation / deployment / return that we saw for the past several years has shifted.   

In addition, the market is asking increasingly hard questions on the returns of all that capex. 

In the end, I’d still argue these are the best companies on planet Earth, but they’re not providing as much upside convexity to S&P as we grew accustomed to.

BUT ... a lack of progress at the index level belies a very strong start WITHIN US equities. 

YTD, equal weight S&P is up 7%.  my old favorite mid cap is back on track and up 9%.  within the S&P, the ratio of stocks that have rallied vs stocks that have sold off is better than 2:1. 

At the industry level, consider these returns: energy +22%, materials +17%, staples +14%, industrials +14%, utilities +10%.  an unusual mix?  yes. 

Fatter tails?  for sure. 

An unhealthy market?  no. 

By the way, with any luck today, S&P (as measured in total returns) will close higher for the 10th consecutive month.

Of course, a defining feature of US equities in 2026 is rotation. 

A switch has been thrown.

• From growth to value. 

• From secular to cyclical. 

• From asset light to asset heavy. 

Part of this reflects an acceleration in nominal GDP. 

Part of this reflects the re-industrialization (and re-armament) of the world. 

And, in the context of AI disruption risk, part of this reflects stock operators moving their capital into the parts of the market that have perceived moats. 

My instinct is these rotations extend a bit further, with short-cycle vacillations along the path, which will continue to drive high dispersion / low correlation.

The mood in software should not be a harbinger of slower growth. 

I understand that price action in certain parts of the market can make the mind wander.  and I’m not dismissive of the impingement risk to the labor market, nor the consequences of that (the hollowing out of American manufacturing is a dreadful analog).  speaking anatomically, however, the US stock market is far more sensitive to the software sector than the US economy is (it comprises less than 1% of total jobs). 

Furthermore, one can argue that profit losses within software will be another industry’s profit gain (I think this is underappreciated). 

Finally, the nature of the bet our economists would make is this: if AI delivers on the promise of productivity growth, that should offset job losses over time, supporting both GDP and earnings.

To review: things have changed -- and some shine has come off S&P -- but things are still good. 

I’m not downplaying the loss of leadership from S&P (it’s the first thing I think of every day).  I’m not saying the lived experience while trading the markets has been easy (as a client put it, this tape has elements of “urban warfare”). 

With all of that said, one can also argue the opportunity set across global equities has been superb, and there have been plenty of places to make good money.  a side note: if you told me S&P would be able to stand its ground while losing the leadership of its two biggest sectors -- tech and financials -- I’d say that’s not a terrible outcome.

In that context, the Asia complex has been lights out. 

The anatomy of Japanese and Korean indices has been ideal -- AI infrastructure, defense contractors, high tech manufacturing -- and those markets just keep going and going.  the interplay of spot up / vol up has been right out of the trading handbook. 

On the flow side, hedge funds have moved aggressively into this space -- taking relative exposure up to 10-year highs -- yet there’s plenty of runway left for domestic retail investors to follow. 

I’m sure there will be pockets of turbulence given the gradient of the recent rally, but I’d keep your eye on the ball in this specific region. 

Here’s an oddity. 

As Pete Callahan points out, the P/E of the tech sector has converged to the consumer staples sector. 

While this can be logically explained in the distinct parts, relative to recent history, it’s an aberration in the absence of risk-off (think Liberation Day, the 2022 rate cycle or COVID). 

This speaks to both the challenge and opportunity set of 2026: certain market axioms and patterns of correlation have been upended (we’ve also seen this in the Japan macro complex). 

This is neither all good, nor all bad, but it sets a context for the next paragraph.   

The hunting should remain good for active managers. 

January was the single best month for discretionary macro hedge funds in four years.  last week was great for fundamental long/short alpha.  again, I’m not saying risk management is easy right now, and the fact is February was trickier than January.  given the totality of stimuli, however, my instinct is the basic game will remain favorable for those who move their feet well. 

Framed another way, the current landscape is the photographic negative of what defined the period (and hamstrung active managers) from the GFC to COVID.

Rich Privorotsky framed the issues of the day very well:

“West to East, asset heavy to asset light.  the pace of change is astounding. 

It is genuinely difficult to keep up with how rapidly new use cases, products and plugins are being created. 

The progression over the last two months arguably exceeds that of the prior two years. 

The result is extreme dispersion. 

The rules that defined the last 20–30 years of markets are being rewritten. 

Some of the best businesses on the planet are being structurally challenged, while some of the worst suddenly look like winners because they own scarce, hard assets or irreplaceable inputs”.

A final point - The prominence of AI within the market narrative this year has been nothing short of overwhelming. 

If the world indeed changed on November 30th of 2022, the current set of debates will be with us for a long time.  with that said, I’m struck by how starkly lines have been drawn and how dogmatic people are in their views (at both ends of the distribution).  I live in the middle and my instinct is humility and open-mindedness are virtues in this entire debate. 

I say all that given this fact set, which is captured in the chart below: in Q4 earnings calls, 54% of S&P companies discussed AI in the context of productivity ... but only 10% quantified the productivity boost from AI on a specific use case ... and only 1% quantified the impact of AI on their current earnings. 

Going forward, would I take the over on 54% / 10% / 1%? 

Of course, but that’s not my point. 

My point is these low figures speak to the fact that it’s still really early ... things are changing really fast ... and who really knows where it all ends up. 

One moral of this little story: be in position to move your feet.    

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