The future of the American financial landscape is becoming increasingly uncertain as we approach the end of the yearNotably, Nelson Armbrus, a managing director at Goldman Sachs, has expressed concern over the challenging conditions anticipated for 2024 and possibly even 2025. He emphasizes that the Darwinian principle of survival of the fittest is particularly relevant within financial markets, implying that only the strongest entities will endure the tumultuous times ahead.
Last weekend, a last-minute deal by Congress averted a government shutdown; however, Armbrus believes this is merely a temporary relief from America's persistent fiscal challengesHe anticipates that a significant sell-off pressure looms on the horizon, especially as the stock market enters a period characterized by low liquidity and year-end holidaysIn his recent report, he highlighted four critical areas that investors should monitor closely.
A record-breaking surge in trading volume marked the end of last week, with December 20 registering a staggering 23.5 billion shares traded across all U.S
exchangesThis figure represents the second-highest daily trading volume in U.Shistory, trailing just behind the peak observed on January 27, 2021, when retail investors heavily bet against GameStop, resulting in an unprecedented volume of 23.67 billion sharesThe high level of trading volume was also fueled by what Armbrus describes as the last major liquidity event of the year, driven by quarterly rebalancing and a simultaneous influx of options and futures during the notorious "Triple Witching" day.
Market imbalances on the day of the trading volume spike were starkly evident, with the closing market-on-close (MOC) sell orders reaching a staggering $12.1 billionThis massive sell-off is a clear indicator of the volatility pervasive in the market, during which the S&P 500 index recorded MOC sell orders totaling $20.3 billion over three trading days, an amount that was threefold compared to the prior two days, where MOC sell orders were $4 billion and $4.2 billion respectively.
Goldman's main brokerage business also reported that the nominal size of short positions taken by hedge funds against U.S
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equities from Monday to Thursday last week reached the highest level since early January this yearOver the past five years, this short position ranked as the 100th largest; meanwhile, Exchange-Traded Funds (ETFs) saw an 8% week-over-week increase in short positions, the most significant percentage rise since April 2020.
As the market plays out, a shift in the strategies of Commodity Trading Advisors (CTAs) became apparent last Wednesday after the Federal Reserve adopted a hawkish stanceGoldman estimates that the flow of capital in the CTAs has morphed from minor sellers to medium buyersBy the close of last week’s trading, there was a notable outflow of over $9 billion from E-mini S&P 500 futures and around $4 billion from E-mini Russell 2000 futures, which will likely impact market dynamics, particularly with many traders stepping into holiday breaks, resulting in thin liquidity.
As of last Thursday, CTAs held $41.8 billion in long positions in E-mini S&P contracts, correlating to 82% of historical holding levels
Similar stats were noted for E-mini Nasdaq 100 and Russell 2000 contracts, suggesting a considerable room for sell-offs with limited opportunities for buyingNonetheless, Armbrus maintains a more optimistic outlook, predicting a bullish trend for the stock market as year-end approaches.
Despite Congress successfully averting a government shutdown, they face an even more significant fiscal dilemmaIn the early hours of last Saturday, Congress passed a bill that permits a temporary funding extension until March 14, 2025, without addressing the ongoing debt ceiling issueIt is anticipated that policymakers will tackle the debt limit at the beginning of next year, with critical deadlines for resolution potentially stretching into July or August.
In a bid to muster Republican support for the bill, the leadership has promised to facilitate an increase in the debt limit by $1.5 trillion next year within a "reconciliation" bill while also projecting $2.5 trillion in spending cuts over ten years, amounting to approximately 0.7% of GDP
Goldman estimates that this proposed increase could delay the debt ceiling expiry from July-August next year to January-February 2026, contingent upon the Treasury Department's cash flow at that time.
The next important fiscal question revolves around whether Republican members of Congress will attempt to push through a "reconciliation" bill within the next year or twoThe strategic advantage of a two-step approach to fiscal spending would allow for immediate passage of priority issues, such as increased immigration enforcement funding and potentially raising the debt ceiling, before transitioning to a second bill to extend expiring tax cuts and introduce new tax measures, offset by budget savings agreed upon by the Republicans.
In contrast, bundling these issues into one comprehensive plan may garner more support, particularly from Republicans advocating for increased immigration enforcement; however, this strategy could exacerbate the inevitable fiscal challenges
Currently, it appears more likely that Republicans will pursue a phased strategy rather than an all-encompassing package.
Armbrus pointedly notes that the Department of Government Efficiency (DOGE) remains unofficially in chargeEfforts to influence the initial $1,500 spending bill have manifested in a considerably condensed version, now trimmed down to 116 pagesSuch developments undoubtedly contribute to the apprehensiveness surrounding the American economy as we transition into a new year.
In conjunction with these market dynamics, investors have begun to speculate on volatility surrounding the upcoming Inauguration DayFollowing the Federal Reserve's hawkish signals, the pricing of options across the board has surgedThis spike in options activity indicates a growing belief among investors in potential fluctuations related to events scheduled for January, further compounded by the sell-off on Friday that likely facilitated funding for these speculative trades.