Hedge Funds Cut Leverage as Market Volatility Hits New Highs
The market has been experiencing significant shifts, particularly in the hedge fund sector. One key observation made earlier highlights the impact of leverage, where overall gross leverage has reached an all-time high. Meanwhile, net leverage and long/short ratios have decreased as hedge fund managers increased their short positions towards the end of the month.
Goldman Sachs' Prime Brokerage team has noted a sharp decline in fundamental long/short net leverage, dropping by nearly five percent. This marks the most significant ten-day reduction since late 2022. Hedge funds are not only reducing their holdings but are also actively shorting positions amid the ongoing market turmoil.
Despite these dramatic moves, US equity markets have made a modest recovery, leading many to question whether the market is showing signs of capitulation. However, leading analysts at Goldman Sachs remain unconvinced. They emphasize that there is little evidence of a panic-driven, indiscriminate selloff indicative of true capitulation. Rather, what is being observed is a calculated reduction in long-only positions, particularly in semiconductor-related stocks and related infrastructure.
A closer look at trading patterns reveals a persistent trend of selling across these groups, especially by major institutional clients. Among the most popular technology and media stocks, there are indications of hedge funds reducing their exposure. Notable names such as APP, SPOT, DASH, META, and AMZN have all shown weakness, despite no significant company-specific news that would typically justify such declines.
Several factors could potentially stabilize the market. One key upcoming event is the earnings report from AVGO, which could act as a pivotal moment for both price action and overall market sentiment. The company has already reported strong revenue growth, surpassing consensus expectations, with particular strength driven by AI semiconductor solutions. The question remains whether the stock can sustain these gains, given the recent pattern of stocks rallying post-earnings only to fade shortly after.
From a technical standpoint, the market appears to be sending mixed signals. The S&P 500 briefly broke below its 200-day moving average before bouncing back slightly. At the same time, many major indices and individual stocks are nearing technically oversold levels. For example, the Nasdaq 100's Relative Strength Index (RSI) stands at 32, while AMZN and TSLA have even lower readings, suggesting that selling pressure may be reaching an exhaustion point.
Another contributing factor to market volatility is the current state of liquidity. Goldman Sachs estimates that liquidity in the S&P 500 has deteriorated to its lowest level in years, now standing at just $3.8 million at the top of the order book. This drop in liquidity makes the market more vulnerable to exaggerated price swings, particularly as dealer positioning turns slightly negative.
Additionally, systematic traders, particularly CTA funds, have been aggressively selling equities, with approximately $47 billion in global equity sales over the past week. Current projections suggest that if the market remains relatively flat, there will be another $40 billion to $43 billion in additional selling pressure over the coming month. However, given that these numbers are relatively similar for both weekly and monthly estimates, it suggests that the bulk of this forced selling could be concluding within the next week.
With the selling pressure from CTA funds potentially nearing its end, attention turns to corporate buybacks as a possible stabilizing force. Corporate buyback programs are currently running at an estimated $5 billion per day. The critical question now is whether these buybacks will be substantial enough to counteract the downward pressure and provide the necessary support for the market to regain its footing.