Recently, a notable characteristic has emerged in the positioning of hedge funds within the U.S. stock market: while maintaining a bullish stance on individual stocks, they have simultaneously built large short positions using index tools. The trading desk at Goldman Sachs (GS) points out that this positioning structure has reached extreme levels, and any positive news could trigger a rapid and strong market rebound.
According to Goldman Sachs’ prime brokerage data, hedge funds overall continue to hold a bullish view on individual stocks. However, the scale of their short hedges established through macro products like ETFs and stock index futures has climbed to its highest level since September 2022. John Flood, head of Americas Equity Execution Services at Goldman Sachs, explains that this strategy of “long stocks, short indices” reflects the market grappling with multiple uncertainties, including the Middle East conflict, concerns in the credit market, and doubts surrounding the AI investment cycle.
However, this structure also sows the seeds for violent market fluctuations. Flood states that due to the enormous short positions in macro products, hedge funds’ gross leverage has reached approximately 307%, near historical highs. Should clear positive news emerge, such as a de-escalation in geopolitical conflicts, investors might be forced to hastily cover shorts, directly pushing indices higher. “The market could rise 2% to 3% in a short period.” He notes that the current “right-tail risk” (the risk of a significant market upside) is actually higher than the downside risk.
Monday’s market action provided an illustration of this dynamic. After President Trump indicated that the war with Iran could be “resolved soon,” the S&P 500 index, which had been down as much as 1.5% during the session, ultimately closed up 0.8%. Traders widely attributed this reversal to investors covering short positions.
The market volatility has also impacted professional investors. Goldman Sachs data shows that due to accelerated sector rotation, fundamental long-short hedge funds saw their year-to-date returns retreat by approximately 4% last week. Meanwhile, long-only investors, including traditional asset management companies and sovereign wealth funds, are opting to stay on the sidelines, awaiting clearer signals.
Amidst market turmoil, corporate buybacks are providing some support. The Goldman Sachs corporate buyback desk noted that the level of buyback activity last week was among the highest in three years, with many companies increasing repurchases, capitalizing on the pullback in stock prices.
Although retail investors remain a significant source of demand, Goldman Sachs believes market volatility could intensify further. Currently, the available liquidity at the best bid and ask prices for S&P 500 futures is only about $4 million, far below the historical average of $14 million. This indicates a significant decline in market depth, meaning large institutional trades will have a magnified impact on prices, thereby increasing market volatility.
The ultimate direction of the market still largely depends on the geopolitical situation. Currently, investors generally anticipate a de-escalation of the Middle East conflict within the next two weeks. If the conflict persists without positive progress, equity indices could face renewed pressure.
