Morgan Stanley quantitative analyst: In late July, the inflow of funds into the U.S. stock market began to slow down, and investors should be prepared for a "5% pullback in August."

Morgan Stanley's quantitative team warns that the pace of capital inflows into the U.S. stock market is slowing, which may make U.S. stocks more susceptible to external shocks.

Chris Metli, head of Morgan Stanley's Quantitative and Derivatives Strategy (QDS) team, stated in his latest report that although the S&P 500 index has risen 25% since its April low, the recent rebound momentum has weakened. The mild CPI data on Tuesday and positive news from Nvidia failed to trigger an accelerated rise, and the market's reaction to headlines has become more rational, only fluctuating under real shocks.

The report emphasizes that passive capital inflows from retail investors, systematic strategies, and stock buybacks are expected to slow down in the second half of July. While this does not mean the rebound is over, it will make the market more fragile.

In the coming month, the market faces multiple potential catalysts, including Federal Reserve meetings, non-farm payroll data, tariff policy deadlines, and companies representing 40% of the S&P's market capitalization will report earnings in the last week of July. The report states that if earnings reports, macro indicators, or tariff policies show negative factors, a short-term pullback of around 5% may occur.

Capital Inflow Data Shows Signs of Slowing

Retail demand for U.S. stocks is slowing according to seasonal patterns.

Morgan Stanley's data shows that the pace of retail capital inflows has dropped from $3.5 billion per day at the beginning of the month to $1.5 billion per day currently, and it is expected to continue slowing as summer progresses.

Historical data indicates that the seasonal strength of the stock market in the first half of July typically begins to weaken from now until August.

Macro systematic strategies have remained significant buyers over the past week, maintaining a buying scale of over $5 billion per day, but Morgan Stanley expects systematic buying to be halved to $2.5 billion per day by the end of the month.

Additionally, many companies are currently in a stock buyback quiet period, which may ease by early August.

Hedge Fund Positions Still Have Room to Rise

From a positioning perspective, the most supportive factor is that hedge fund net exposure remains at a moderate level.

Morgan Stanley points out that hedge fund net positions are currently at 51%, at historical median levels, and U.S. long-short strategies have recorded a profit buffer of 4.9% year-to-date. The report believes that considering the good market performance, positive fundamental trends, and the limited potential impact of tariffs, this moderate positioning leaves room for upside. This means that before the market turns downward, hedge funds may need to further increase their holdings, driving a "high first, then low" dynamic.

Bullish factors also include that when the market declines, dealers' gamma exposure will increase, potentially providing support. Although dealers may not have much long gamma after deducting the short gamma from leveraged ETFs at the current level, the long gamma from options could double with just a 2% decline, which may slow any downward trend.

Multiple Events Concentrated at the End of July

Looking ahead to the end of the month, several potential market-moving events are gathering: Federal Reserve decision, non-farm payroll data (weak data may strengthen rate cut expectations), and the approaching "tariff deadline."

More importantly, companies representing 40% of the S&P 500 index's market value will release earnings reports in the last week of July. Previous research by Morgan Stanley shows that when a large number of market-cap companies release earnings reports on the same day, the absolute return of the S&P 500 index tends to be larger and slightly skewed towards negative.

The bank estimates that there will also be a supply pressure of $17 billion in asset allocation. These factors combined may trigger a market pullback when there is any noise regarding earnings reports, macro data, or tariff policies