As U.S. stocks hit new highs: Retail buying fades, hedge funds short at the fastest pace in four months

While the U.S. stock market is reaching new highs, hedge funds are accelerating their exit from the market, and at the same time, retail investors' buying has also declined.

Goldman Sachs data shows that last week hedge funds net sold U.S. stocks at the fastest pace in four months, with a short-selling to buying ratio of 3.5:1. In stark contrast, long-term investment funds net bought $4 billion during the same period.

This reverse operation occurred while the S&P 500 index rose 2.5% and closed at a historic high. The net selling scale of hedge funds reached $1 billion, with over 90% concentrated in macro products (indices and ETFs), and short positions in U.S.-listed ETFs increased by 4%.

JP Morgan data indicates that retail investor participation has also declined, with net purchases of $4.9 billion last week, below the weekly average of $6.6 billion for the year. Institutional investors and retail investors exhibit completely different strategies in ETF and individual stock selection, reflecting a significant divergence in current market participants' views on future market trends.

Analysts point out that hedge funds' cautious attitude towards the outlook for U.S. stocks contrasts with record corporate earnings performance and stock prices hitting new highs. This divergence may indicate that significant changes are occurring in the underlying structure of the market.

Hedge Funds Significantly Reduce Holdings

According to Goldman Sachs Prime Brokerage data, hedge funds exhibited clear structural characteristics in their short-selling behavior in the U.S. stock market last week. In terms of macro products, the ratio of short-selling to long-selling reached about 4 to 1, with short positions in U.S.-listed ETFs increasing by 4%, a monthly increase of 5.7%.

Technology stocks have become the main target for hedge fund short-selling. The information technology sector has faced net selling for the third consecutive week, with the selling speed being the fastest in over four months, and the short-selling to long-selling ratio reaching 3.9 to 1. All technology sub-sectors experienced net selling, with the technology hardware, software, and semiconductor equipment industries leading the decline.

From the holding structure, information technology currently accounts for 19.2%/16.4% of the total exposure/net exposure in the Prime book for U.S. stocks, ranking in the 71st and 11th percentiles respectively over the past five years.

Additionally, the financial, industrial, and energy sectors also experienced significant net selling, while consumer discretionary, communication services, healthcare, and real estate sectors saw net buying.

The real estate sector performed outstandingly, experiencing the largest net buying in 3.5 months, entirely driven by long buying, with net buying in 4 out of the past 5 weeks. Residential REITs, real estate management and development, office REITs, and healthcare REITs led the gains.

Goldman Sachs states that the total leverage ratio of long-short strategies has decreased for the fifth consecutive week by 0.5 percentage points to 207.6%, and the net leverage ratio has decreased by 0.2 percentage points to 52.5%. The long-short ratio has remained essentially unchanged at 1.676

Retail Investor Buying Pressure Cools

Retail investor participation also declined last week.

JP Morgan's Retail Radar report shows that retail net purchases were $4.9 billion, which is not only below the weekly average of $6.6 billion so far this year but also below the weekly average of $5.6 billion over the past 12 months. Despite the recent strong market performance, retail activity remains far below the levels seen in March and April.

Notably, in terms of investment preferences, unlike hedge funds that focus on shorting macro products/ETFs, retail investors show the opposite preference. Specifically:

Retail investors continue to favor ETFs ($4.7 billion) over individual stocks ($276 million). Large-cap stock ETFs saw a net inflow of $2.2 billion, while money market funds and large-cap growth stock ETFs received inflows of $535 million and $209 million, respectively.

In terms of specific asset selection, QQQ received the largest net inflow of $724 million, while SPY and VOO received $715 million and $408 million, respectively.

Regarding individual stocks, Nvidia, Amazon, and Palantir became the most favored targets by retail investors, with net purchases of $453 million, $453 million, and $253 million, respectively.

Earnings Season Volatility Exceeds Expectations

The current earnings season is exhibiting unusually high volatility characteristics. According to data tracked by Goldman Sachs, stock price fluctuations on earnings days have exceeded the expectations of options investors for the first time since 2018.

The average volatility of S&P 500 constituents reached ±5.3%, a 15-year high, surpassing the implied volatility level of 4.7%.

In terms of earnings performance, 60% of companies had EPS that exceeded expectations by more than one standard deviation (the historical average is 48%), while only 9% of companies fell short of expectations. However, this seemingly good performance has not translated into sustained stock price increases, reflecting the market's high sensitivity to valuations.

Performance across sectors has shown significant divergence. After another week of gains, the market began to focus on Apple's 12% increase over three consecutive days, as well as the extreme weakness in the software sector.

The price response in the consumer sector has generally been weak, with stock performance being unsatisfactory regardless of earnings results. The industrial sector, although up nearly 100 basis points, has clearly underperformed the broader market.

Looking ahead to this week, market focus will shift to macroeconomic data, including Tuesday's CPI data, Thursday's PPI data, and Friday's retail sales data, as well as trade-related news.

Additionally, the earnings season is nearing its end, with only 1% of S&P market cap companies yet to report earnings, and implied volatility indicates that the expected volatility for the S&P 500 this week is only 1.25%