As retail investors become greedy, smart money begins to reduce long positions in U.S. stocks

As retail investors' greed reaches a peak, "smart money" is quietly retreating.

Recently, Simon White, a macro strategist at Bloomberg, published an analysis article that delves into a concerning phenomenon in the current stock market. As a seasoned macro analyst, White reveals through tracking the movements of "smart money" that beneath the seemingly prosperous surface of the U.S. stock market, hidden risks are accumulating.

The article points out that although the U.S. stock market appears to be rising, hedge funds, represented by macro funds and quantitative funds, have shown a clear indifference towards stocks. White believes that this shift typically signals a decline in future market returns.

At the same time, the overall market sentiment has begun to shift from "fear" to "greed," with retail investors' speculative enthusiasm surging. White warns that the current market environment is showing signs of fragility. As he puts it, "It is precisely because greed is seeping into this rebound that we should pay special attention to the caution of 'quick money.'" This greed is often difficult to sustain, and historical data shows that once greed dominates, the stock market typically performs poorly in the following one to three months.

The Divergence Between "Smart Money" and Retail Investors

White points out at the beginning of the article that 2025 will be a tough year for hedge funds, with their overall return rate lagging about five percentage points behind the S&P 500 index. Macro funds and Commodity Trading Advisor (CTA) funds are among the worst-performing groups.

Data shows that, with few exceptions, these funds did not profit during the market rebound from its lows. Although they eventually established long positions, they quickly lost confidence in the upward trend in July, with their sensitivity to the S&P 500 index returns dropping to nearly zero.

So, does this mean they have sensed something? White believes the answer is likely affirmative. The data he provides indicates that when macro funds and CTA funds, the "smart money," short stocks while retail investors are going long, it historically signals that the stock market will tend to weaken in the next 1-3 months.

Specifically, in this scenario, the average return rates of the S&P 500 index for the next one, two, and three months are -0.1%, 0.2%, and 1.6%, respectively, all significantly lower than the historical average return rates for the same periods, which are 0.7%, 1.4%, and 2.3%.

Greed Replaces Fear: A Dangerous Signal

On a deeper level, the reason these funds remain cautious is precisely because greed is seeping into this rebound. White emphasizes that it is due to the emergence of greed that we should pay special attention to the cautious attitude of "quick money." This emotional shift can be observed from multiple dimensions:

• Speculative stocks soar: The "most shorted stock basket" compiled by Goldman Sachs has recently surged at a record pace. At the same time, the bank's "speculative trading indicator," which tracks meme stocks, loss-making companies, and high price-to-sales ratio companies, has also risen to a three-year high.

• Options market signals: Market sentiment has shifted from the "fear" dominance seen in the early stages of the rebound (investors hedging downside risk with put options) to a recent "greed" dominance. White defines the "greed mechanism" as: the implied volatility of out-of-the-money call options performing better than that of out-of-the-money put options, and the fear index VIX is declining. History shows that "greed rarely has good outcomes; once it dominates, the stock market typically performs poorly in the next one to three months."

• Bred complacency: White warns, "Unlike greed, complacency is not one of the seven deadly sins, but it should be in the market." Collective overconfidence is the source of many market downturns. A clear sign is the decline of short-term implied volatility relative to long-term implied volatility. This can be measured by the VIX/VXV ratio (VIX measures the volatility for the next 30 days, while VXV measures the volatility for the next 90 days). When this ratio rises rapidly, it indicates that the market believes "risk is in the future, but not important today." This mindset, when it reaches extremes, is often associated with short-term reversals in the stock market.

More concerning is that this calm volatility is not limited to the stock market. White points out that cross-asset volatility covering stocks, bonds, credit, foreign exchange, and oil is declining across the board. This suggests that the market does not seem to have any "scars" from some truly unprecedented events in recent months, such as the trade war.

Potential Risks Under Low Correlation

The article also delves into a technical yet crucial concept: the implied correlation of stocks. This metric measures the degree of co-movement among individual stocks in the S&P 500 index. When correlation is low, it means stocks are moving more independently rather than rising and falling together.

Why is low correlation a potential risk? White explains that during stable market conditions, low correlation can artificially suppress the VIX index. However, once the market begins to decline, stocks tend to move more in sync (in extreme cases, investors sell everything, and correlation tends toward 1). At that point, correlation will quickly rebound, driving the VIX index to soar, which in turn triggers further selling, creating a vicious cycle. Therefore, the current low correlation acts like a potential "downward accelerator."

Contrarian Perspective

Interestingly, at the end of the article, White also provides a contrarian perspective. According to Nomura Securities data, CTA funds seem to have just given up shorting, with their long positions reaching the highest level in at least three years White acknowledged that the indicators he uses to analyze fund trends have a certain lag, and macro and quantitative funds may have also re-established long positions in the past week or two.

However, this chasing behavior itself carries significant risks. White ultimately issued a clear warning: considering these funds' poor returns previously, if they are now hastily chasing this "stubborn" rebound, they better pray that they are right this time.