Just as retail investors are rushing into US stocks, hedge funds are rapidly reducing their positions in US stocks. Market analysis suggests that the retreat of hedge funds' positions in US stocks may indicate a shift in market sentiment.
With the weakening of the rebound in the US stock market, hedge funds are "surrendering" to the US stock market. Last week, hedge funds reduced their positions in US stocks at the fastest pace since the short-selling in 2021.
On Monday, July 31st, according to data compiled by the bulk brokerage department of JPMorgan Chase, fund managers who simultaneously bet on both bullish and bearish US stocks significantly reduced their positions in both directions. The extent of position adjustments reached the highest level since the short-selling triggered by retail investors in 2021.
Hedge fund clients of Morgan Stanley also showed a similar pattern of reducing their positions in US stocks, although at a slower pace. However, their position reduction last week was the largest this year. At Goldman Sachs, hedge fund clients reduced their positions in US stocks on 12 out of the past 14 trading days.
Market analysis believes that the retreat of hedge funds' positions in US stocks may indicate a shift in market sentiment. At the beginning of this year, almost every fund manager adopted a defensive strategy and was then forced to adapt to the rise of US stocks. The upward trend of US stocks began in October last year, during which, except for two months, the S&P 500 index rose by 28%. It is only about 200 points away from fully recovering from the bear market in 2022.
Analysts at JPMorgan Chase wrote in their report:
Although the rise of US stocks may be beneficial to those who are long in the market, it is quite challenging for high-frequency short sellers. The rise of US stocks seems to be triggering a widespread surrender of fund managers by reducing their positions.
This is the latest pain that the rise of US stocks has brought to hedge funds this year. As the US economy has withstood the test of the Federal Reserve's aggressive rate hikes, US stocks have not fallen as predicted by most forecasters, but have soared. In this process, fast money managers were forced to cover their short positions and chase returns, while strategists rushed to raise their year-end target prices for US stocks.
Hedge fund managers are not yet prepared for a bull market
Since all the negative factors in December last year laid the foundation for the strong rise of US stocks in this round, now every fund manager is considering whether the pendulum of market sentiment has turned to another extreme.
According to Morgan Stanley's sales and trading team, a group of early bulls may run out of ammunition. Their estimates show that hedge funds that allocate assets based on volatility or trend signals have been increasing their positions in US stocks, with their net leverage ratio remaining above 80% over the past five years.
With the increase in risk exposure, Morgan Stanley believes that once US stocks become turbulent, these fund managers may sell a large amount of their holdings of US stocks. According to the bank's calculations, if the S&P 500 index falls by 5% in a trading day, it may lead to the sale of $180 billion worth of stocks next week.
Morgan Stanley's client data shows that the net exposure of hedge funds to US stocks has dropped from 49% last week to 47%.
Eric Boucher, Co-Head of Sales at Renaissance, also noticed a similar sentiment. He said:
**In my conversations with fund managers, I found that they are still not prepared for a bull market, and they are still concerned about the macroeconomic situation. For example, if the US economy loses momentum, there may be a wave of bond defaults. **
Contrary to hedge funds, retail investors are once again flooding into the US stock market
Despite hedge funds reducing their positions in US stocks, according to a survey by the National Association of Active Investment Managers (NAAIM), the exposure to the US stock market has just reached its highest level since November 2021, driven by the enthusiasm of retail investors for popular stocks.
Data on retail fund flows released by Vanda Research in mid-July showed that retail investors in the US stock market are rushing in, continuing to chase gains primarily through US technology stocks, electric vehicles, bonds, and a wide range of stock ETFs.
Vanda Research expects retail investors' net buying to remain high throughout the earnings season. The firm points out that retail investors tend to engage in "contrarian investing," meaning they "buy high and sell low." If the stock market continues its upward trend, it is expected that a significant amount of retail investor funds will flow in.
The firm stated that since the surge in the number of retail investors in the US stock market in 2020, "retail traders have never been so actively buying stocks before the 'official' start of the earnings season."
However, market participants who are bearish on the US stock market believe that a comprehensive perfect storm is brewing.
At the end of 2021, retail investors also rushed to buy, but then encountered a brutal bear market: when retail investors flocked to the market at the beginning of the year, the VIX index and the put-call ratio were at low levels. However, by early January 2022, the three major stock indices had already peaked, and the S&P 500 had fallen by 19% over the year.