Hedge funds have been net sellers of U.S. equities for three consecutive weeks—precisely during the period when the S&P 500 has been reaching new all-time highs and setting fresh historical closing records for three weeks straight. Brian Garrett, a derivatives trading expert at Goldman Sachs, warned in a weekend memo that discussions on the bank's trading desk continue to focus on how spot prices are "ignoring the bigger picture," suggesting that a 3%-5% sell-off in the S&P 500 is "only a matter of time."
It is noteworthy that fundamental long/short hedge funds just recorded their best single-month return on record in April, at +9.1%.
Despite achieving historically strong returns, these funds are exiting the market at the fastest pace. Data from Goldman Sachs Prime Brokerage shows that hedge funds have been reducing exposure to U.S. stocks for three weeks running—selling long positions and shorting individual stocks, with only partial offset from short covering in macro products. The department described this activity as "adopting more cautious risk management at market highs."
Allocation divergences have reached extreme historical levels: hedge funds' allocation to North American equities relative to the MSCI ACWI index has dropped to its lowest level since records began, while they are significantly overweight emerging markets. Garrett himself expressed surprise at this data.
The technology sector is bearing the brunt of the selling. The information technology sector saw substantial reductions in exposure for two consecutive weeks, with the ratio of long selling to short covering at 1.5:1. Excluding the meme stock frenzy of early 2021, the deleveraging in U.S. tech stocks over the past two weeks has been the most severe in a decade (-2.7 standard deviations). Most sub-sectors experienced reductions, led by semiconductors, tech hardware, and software. The Mag 7 stocks were net sold on four out of the past five trading days, with the intensity of long selling outweighing short covering. Another notable signal comes from Goldman Sachs' cash trading desk: asset managers are becoming net suppliers of equities. It remains unclear whether this is routine portfolio rebalancing or an expression of a directional view. Matt Kaplan of Goldman Sachs observed, "There seems to be a sense of investor paralysis; Wall Street remains in a digestion mode."
Multiple Cracks Beneath the Surface of New Highs While the S&P 500 is making new highs, the "quality" of these highs is deteriorating—four out of the last five record closes occurred with negative market breadth, meaning more stocks declined than advanced. The volatility market is also sending conflicting signals. The VIX has retreated significantly, and index implied volatility is low, but single-stock volatility is extremely high—implied correlations have collapsed, and dispersion has surged. Garrett pointed out that over the past month, the average daily gain has been about 85 basis points, while the average daily loss has been about 75 basis points. The traditional meaning of "skew" is being reshaped, and the market is experiencing what he terms an "up crash." Simultaneously, the cost of one-month at-the-money put options on the S&P 500 has dropped from about 300 basis points at the end of March to approximately 150 basis points, making protection very cheap. The +9.1% return in April刚好 brought hedge funds from a year-to-date loss into profitability—Garrett said he "doesn't blame" clients for taking advantage of cheap prices to lock in downside protection. Last Wednesday was one of the busiest trading days of the year for Goldman's index trading desk (excluding days when the VIX was above 20), with investors heavily purchasing downside options expiring on May 15th and 29th to hedge risks associated with large-cap tech earnings. On the flip side, July expiry implied volatility sitting at just 12.5 also makes going long attractive—trading volume in call options for the large-cap TMT sector exploded last week. Regarding CTAs, the explosive demand that previously provided the largest incremental buying for the market has ended, turning into moderate selling pressure. In a flat market scenario, there is approximately $10 billion worth of potential selling over the next week and about $21 billion over one month. Momentum support thresholds lie in the S&P 6800-6900 range.
In contrast to institutional caution, passive funds are flooding in. The QQQ ETF saw net inflows of $10 billion in April, a record for its largest single-month inflow. Semiconductor ETFs attracted approximately $5 billion in net inflows, also a historically significant level. Trading volume in a triple-leveraged semiconductor ETF last week particularly drew market attention. Furthermore, a high-beta momentum pair basket recorded one of its worst single-day performances on record following a Wall Street Journal report about OpenAI; this factor remains crowded, and Goldman's trading desk has observed clients shifting towards defined-loss protection strategies.
Goldman Trading Desk Preferences and Earnings Season Signals Garrett believes that "the easy money from simply going long beta has been made." His current preferred directions include:
Going long gold ("feels like the timing is right"); Going long emerging market tech stocks, which are cheaper than their U.S. counterparts—open interest in call options for the South Korea ETF (EWY) has surged to a record high; Going long AI infrastructure (U.S. industrial stocks continue to be sold, creating short-squeeze potential); Going long hyperscale cloud providers while being underweight semiconductors—Goldman Sachs formally launched this strategy last Thursday.
As a "hedge against the consensus" trade, he is also discussing the possibility of Europe's SX5E index outperforming the Nasdaq—stating that "being underweight Europe and long U.S. tech" is already a crowded trade.
Regarding the earnings season, according to Ben Snider, Goldman Sachs' chief U.S. equity strategist, 63% of S&P 500 companies have reported Q1 results. Of these, 61% have beaten earnings estimates by more than one standard deviation, while only 5% have missed by more than one standard deviation (the lowest miss rate excluding the COVID period). Q1 EPS growth is on track to be the highest in five years. However, the initial expectations bar was set very low, and stocks that beat estimates have received almost no reward—the excess return is only about 20 basis points, among the lowest on record. This week, 128 S&P 500 constituents (representing 11% of the index's market cap) are scheduled to report earnings. AMD is the most watched, with an implied earnings move of 7.2%; its stock fell 17.3% following its last earnings report.
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