Speculative trading is booming again. That could turn into a headwind for the S&P 500, says Goldman Sachs

Goldman Sachs reports a sharp increase in speculative trading, characterized by elevated volumes in unprofitable stocks, high call option activity (61% of total), ballooning IPO first-day returns, and a record short squeeze. While their Speculative Trading Indicator remains below 2000 and 2021 peaks, this heightened risk appetite, which correlates with retail investor favorites, historically signals above-average S&P 500 returns in the short term but increases the risk of a downturn on a 24-month horizon.

Analysis

While the S&P 500 and Nasdaq have reached new record highs, there is a concurrent and sharp increase in speculative trading activity, signaling potential market fragility. According to Goldman Sachs, their Speculative Trading Indicator has risen significantly, reflecting elevated trading volumes in unprofitable companies, penny stocks, and firms with high enterprise value-to-sales multiples. Although this indicator remains below the extreme peaks of January 2000 and February 2021, other metrics corroborate the heightened risk appetite. Call options have surged to 61% of total option volumes, the highest proportion since 2021, and first-day returns for IPOs have ballooned. Furthermore, the market has witnessed one of the most intense short squeezes on record, with Goldman's basket of highly shorted stocks rallying over 60% since early April, a three-month return only surpassed during the 1999-2000 and 2020-21 periods. This speculative fervor has occurred alongside narrow market breadth and neutral average investor positioning. Historically, such sharp increases in speculative activity have signaled above-average S&P 500 returns over subsequent 3-to-12-month periods, but these gains are typically followed by faltering returns on a 24-month horizon.

Key Decisions for Investors

• Given the historical precedent of short-term gains following speculative surges, investors may consider maintaining tactical exposure but should heighten vigilance for signs of a market top.
• Investors should monitor the key indicators of froth mentioned, including the proportion of call option volumes, IPO first-day performance, and the intensity of short squeezes, as a continued acceleration would increase medium-term downside risk.
• Considering the negative 24-month return outlook following similar environments, long-term investors should evaluate their portfolio's exposure to the most speculative assets and consider trimming positions in unprofitable or extremely high-valuation stocks.