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In the current market dynamics, there seems to be a striking separation between the behavior of hedge funds and retail investors. As the biggest five Mega Tech stocks, such as Amazon and Nvidia, are hitting all-time highs, a segregation is emerging in the market with hedge funds reducing their holdings and retail investors continuing to buy. This contradiction raises questions about the sustainability of the current increases and the potential impact on the broader market.
According to a recent market update from Vanda Research there has been a notable decline in the trading activity of retail investors in the second quarter of this year. It's unusual for net purchases of U.S. stocks and ETFs to remain below $1 billion per day, a trend that has now persisted for 45 consecutive trading days. This is the longest period of low activity since the pandemic.
Despite this low activity, there are no signs of Panic selling among retail investors. On the contrary, the purchase of leveraged products continues unabated and there are no mass liquidations. In fact, sentiment indicators point to above-average levels of optimism.
Vanda Research draws parallels with the second half of 2017, when markets also performed strongly despite a reluctance among retail investors. At the time, institutional investors were the driving force behind the increases. The return of retail investors was ultimately triggered by the transition to a new quarter and the start of the earnings season.
This could also be a possibility now. The new quarter and the approaching U.S. earnings season could well be the catalysts that pull retail investors back into the market. If Institutional investors Selling shares due to disappointing earnings can provide opportunities for retail investors to get in at lower prices.
The downturn in retail investor activity is also impacting overall revenue, which is now back to pre-pandemic levels. Vanda Research notes that retail sales, measured as the dollar value of purchases and sales, fell below $10 billion for the first time since January 2020. While this may seem concerning, it's still unclear if this is here to stay. Previous declines in sales recovered quickly, often coinciding with higher net inflows.
Remarkably, despite the overall decline in market-wide purchases, retail investors continue to focus on Mega Tech Stocks and semiconductor companies like Nvidia. Investors also continue to buy leveraged products such as the 2x long NVDL ETF, which has reached a market cap of over $4 billion within six months. This concentration has also attracted the attention of short-sellers, indicating potential volatility in the future.
At the other end of the spectrum, hedge funds are actually reducing their exposure to technology stocks. According to a report by Goldman Sachs Prime Brokerage, hedge funds have been aggressively net selling in the past month, especially in the technology, media, and telecommunications (TMT) sectors. These sales include big names like Nvidia, which is a reversal of the trend from earlier this year.
The decline in exposure of hedge funds is driven by long sales and, to a lesser extent, by covering short positions. Despite the recent sell-off, hedge funds' leverage ratios remain higher than their historical average.
Underneath the apparent calm of the market lurks a dynamic of distribution, with hedge funds selling large amounts of tech stocks to retail investors. While retail investors are concentrating their portfolios in a small number of popular stocks, hedge funds are reducing their exposure amid fears that the party is almost over.
Vanda Research emphasizes that the situation among retail investors seems calm at the moment, but that the underlying dynamics need to be closely monitored. The increasing popularity of Leveraged products among retail investors can become a source of instability. Hedge funds try to stay ahead of this potential volatility by reducing their holdings.
In this context, it remains to be seen whether the approaching earnings season and the transition to a new quarter will be enough to attract retail investors back to the market, and what impact this will have on the broader market.
