Scared by the volatility! Last week, investors liquidated stocks at the fastest pace in four years, while hedge funds collectively reduced their exposure to Japan

After a week of turmoil, investors who suffered heavy losses, especially hedge funds, rushed to withdraw from various high-risk positions.

Data from Deutsche Bank shows that investors reduced their stock allocations at the fastest pace since 2020 last week.

A report released last week by Deutsche Bank strategists like Parag Thatte stated that the overall stock allocation is currently at the 31st percentile and in a selling state. Just three weeks ago, the stock allocation was at its historical high of the 97th percentile.

In a report last week, J.P. Morgan pointed out that commodity trading advisors (CTAs), fund managers who track market trends, began to significantly unwind long positions in stocks, short positions in the yen, and short positions in Japanese stocks after the U.S. released disappointing employment data on August 2.

Goldman Sachs also released a report to clients on Friday, showing that long-short equity hedge funds reduced their overall exposure to Japan from 5.6% the previous week to 4.8% last week, while also cutting the leverage of the overall investment portfolio by nearly one percentage point to 188.2%.

Furthermore, according to data released on Friday by the U.S. Commodity Futures Trading Commission and the London Stock Exchange, in the past week, hedge funds reduced their net short positions in the yen to the lowest level since February 2023, indicating that investors have also significantly cut back on yen carry trades.

Global Markets Witness "Big Reversal," Hedge Funds Suffer Heavy Losses

Due to a series of weak economic data and escalating fears of a U.S. economic recession, global markets witnessed a "big reversal" last week: from yen carry trades to cryptocurrencies, and to AI-supported tech stocks, almost all previously profitable bets were wiped out.

The U.S. stock market experienced a heart-stopping "roller coaster" ride, with the CBOE Volatility Index, which measures its volatility, hitting its highest closing level in nearly four years on August 5. Although the S&P 500 index almost recovered from last week's losses, it still remains nearly 6% below its historical high in mid-July.

The market crash led to heavy losses for hedge funds.

According to risk exposure models from hedge fund research firm PivotalPath, global macro quant funds lost between 1.5% and 2.5% from August 1-5 alone, while tech-focused hedge funds fared even worse, losing between 2.5% and 3.5% during the same period.

Some Hedge Funds Emphasize "No Panic"!

After the unexpected surge in the U.S. unemployment rate in July triggered the well-known recession indicator, the Sam Rule, concerns about the world's largest economy slipping into a recession intensified. Deutsche Bank predicts that U.S. corporate earnings growth will slow to "low single digits," compared to an 11% growth in the second quarter.

According to data compiled by media research, analysts expect earnings of S&P 500 index component companies to grow by 5.3% and 11.3% in the third and fourth quarters, respectively Despite the market's sharp fluctuations, hedge funds remain stubborn, claiming there is no fear of a U.S. recession. Edoardo Rulli, Chief Investment Officer of Solutions at UBS Hedge Fund, stated:

We have indeed seen a certain degree of deleveraging. This is not panic, but portfolio managers are reducing positions.

Rulli also mentioned that while macro hedge funds were long U.S. rates and profited during the market's sharp decline, they are also reconsidering some positions.

Macro hedge funds still have confidence in the steepening yield curve, but they are taking profits as the yield curve has performed well over the past four weeks.

Roller-coaster Market May Continue Before September Rate Decision

Currently, the market generally believes that a rate cut by the Federal Reserve in September is a "done deal," but there is still disagreement on the extent of the cut.

According to the FedWatch tool from the Chicago Mercantile Exchange on August 11th, the likelihood of the Fed cutting rates by 25 basis points or 50 basis points at the next meeting in September is almost equal.

Richard Lightburn, Deputy Chief Investment Officer of MKP Capital Management, a macro hedge fund, stated:

If the probabilities of a 25 basis point cut and a 50 basis point cut by the Fed are equal, then uncertainty is at its highest. This indicates that the market really doesn't know what will happen next, meaning volatility will continue.

Sophia Drossos, Economist and Strategist at Point 72 Asset Management, mentioned that a sudden surge in volatility could dampen risk appetite until investors have more confidence in global growth prospects.

When your long trades suddenly start unwinding, it does hurt risk appetite.

We may see investors once again being cautious or more cautious about taking on too much risk. This could be a negative factor for the remaining summer months of this year.

Deutsche Bank also stated that if volatility remains high, systematic funds may face further pressure to reduce their equity exposure, "even though their sensitivity to market sell-offs has decreased."

This week, the focus in the U.S. stock market shifts to a series of key economic indicators and corporate earnings reports—July CPI inflation, retail sales data, initial jobless claims, earnings of global retail giants, etc. Investors will assess whether American households are facing higher inflation and more pressure from higher interest rates.

Some analysts believe that a downturn in inflation is already a market consensus, and the retail and initial claims data released this week may be more important than PPI and CPI, "From now on, the data will tell us about the U.S. economy: whether it is gradually slowing down or plummeting sharply."