Following the most significant short squeeze since November 2020, hedge funds have pivoted their strategy within just one week, renewing their focus on building bearish positions.
Last week, a surprisingly weak nonfarm payrolls report unexpectedly served as a catalyst, triggering a broad rally in U.S. equities. The S&P 500 index hit its 26th all-time high for the year, and expectations for a September rate cut increased, which helped absorb the prior technical selling pressure. However, according to Goldman Sachs' latest Prime Brokerage weekly report, after this rally subsided, hedge funds swiftly reversed course. They were net sellers of U.S. stocks last week, with short-selling activity once again surpassing long buying.
This rapid shift highlights the extreme instability of current market sentiment. After a brief period of sentiment repair, institutional investors have not formed a sustained consensus for buying. Instead, they have chosen to re-establish short positions, particularly concentrated in macro products and the energy sector.
The Squeeze Calms Quickly, Leverage Data Retreats
According to the Goldman Sachs Prime Brokerage report, the market notably calmed down last week, just seven days after the largest short squeeze since November 2020.
The total gross leverage for U.S. long/short funds fell by 3.9 percentage points to 204.2%, placing it in the 6th percentile over the past year, indicating that overall risk exposure remains low. Meanwhile, net leverage edged up 0.8 percentage points to 53.6%, sitting in the 60th percentile for the year. The U.S. fundamental long/short ratio (by market cap) increased by 1.9% to 1.712, which is in the 97th percentile for the last year.
Looking at the background that triggered last week's rally, the weak nonfarm payrolls data caused the probability of a September rate cut to plunge from near certainty to around 40%. The market responded with a "bad news is good news" logic. Earnings reports from the software and internet sectors were strong. Atlassian (TEAM) surged 30% in a single week, Twilio (TWLO) rose 25%, and the IGV index increased by about 3%, driving some short covering. In contrast, popular long positions in semiconductor stocks generally faced pressure, with stocks like Micron and AMD declining.
Macro Products Become the Main Battleground for Shorting, Single Stock Flows Are Flat
In terms of capital flows, hedge funds were net sellers of U.S. stocks last week, primarily driven by short-selling activity in macro products (the combined category of indices and ETFs).
Net selling in macro products reached -0.6 standard deviations from the one-year average, with a ratio of short-selling to long buying of 2.2 to 1. Short interest in U.S.-listed ETFs declined for the fifth consecutive week, down 12% month-over-month. This decline was mainly due to short covering in credit and large-cap ETFs, though new short positions in small-cap ETFs partially offset this effect.
For single stocks, net flows were roughly flat, with the volume of long buying and short selling being approximately equal. Notably, single-stock trading volume last week was the largest in seven weeks, and trading activity increased in 10 of the 11 sectors (excluding Information Technology). The Financials, Communication Services, Healthcare, and Materials sectors saw the largest net buying, while Information Technology, Industrials, Consumer Discretionary, and Energy were the sectors with the most net selling.
Financial Stocks Bought for Four Straight Weeks, Energy's Seven-Week Buying Streak Ends
The Financial sector was one of the largest sectors for net buying by hedge funds last week and over the past month. Goldman Sachs data shows that hedge funds have been net buyers of financial stocks for four consecutive weeks, with a buy-to-sell ratio of 3.8 to 1. The intensity of net buying was at +1.0 standard deviations from the one-year average.
Breaking it down, Trading & Payment Processing, and Capital Markets (exchanges & data, investment banking & brokerage) were the sub-sectors with the largest net buying this week, while Banks and Insurance were the sub-sectors with the most net selling. In terms of relative weight, hedge funds' overweight position in Financial Services (including Capital Markets and Trading & Payment Processing) is at its highest level in three years. Their underweight position in Insurance is also the deepest in three years, while the relative weight in Banks is at the 35th percentile over the same period.
For the Energy sector, after seven consecutive weeks of net buying, there was a small net sell-off last week. The intensity of net selling was -0.4 standard deviations from the one-year average, with a short-selling to long buying ratio of approximately 4 to 1. Integrated Oil & Gas and Oil & Gas Storage & Transportation were the sub-sectors with the most net selling, while Exploration & Production, and Drilling & Equipment Services saw net buying. Despite this, the net exposure of U.S. Energy stocks as a percentage of total U.S. net market value is still 4.0%, sitting between the 95th and 98th percentile over the past one and three years. The sector's overall long/short ratio is 1.87, placing it between the 99th and 100th percentile over the same periods, suggesting that overall positioning remains relatively bullish.
Market attention has now turned to this week's dense macro calendar. The July CPI data, due on Wednesday, will be a key focus, with the market expecting a 0.2% month-over-month increase in core CPI and a 2.5% year-over-year rise. Thursday will see the release of PPI data, and Friday will bring retail sales figures. Additionally, the U.S. Treasury will auction $58 billion in 3-year notes on Tuesday, $42 billion in 10-year notes on Wednesday, and $25 billion in 30-year bonds on Thursday, creating a supply pressure that cannot be ignored.
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