What Are Hedge Funds' Top Buys After the Brutal Market Sell-Off?

While newbie investors bailed, hedge funds that make both bullish and bearish equity wagers seized the opportunity, snapping up stocks during the market turmoil. This aggressive buying by professional traders suggests a belief that the recent volatility may be an overreaction to economic data that, while weakening, has yet to confirm a recession. The sharp rebound in shares from their lows indicates hedge funds may have been onto something. However, it will take more than just a "turnaround-Tuesday" to confirm that the pros have outmaneuvered day-traders in a market where valuations remain high.

"Nearly all tech subsectors were net bought on Monday (sans tech hardware), led by semis & semi equipment and software," said Vincent Lin, Vice President at Goldman Sachs, in a note to clients. Despite this activity, hedge funds remain underweight in information technology, holding at levels unseen in over a decade.

In addition to tech, hedge funds also snapped up fairly-valued stocks in healthcare, staples, and utilities. However, they reduced their holdings in consumer discretionary, real estate, and financials sectors. This buying activity comes after a period where hedge funds had been net sellers, increasing their bearish positions for about two weeks leading up to Monday's market drop.

JPMorgan Chase & Co.’s trading desk suggested that the rotation out of the technology sector may be nearing its end, indicating a tactical opportunity to buy the dip as the market stabilizes.

“Overall, we think we’re getting close to a tactical opportunity to buy-the-dip and our Tactical Positioning Monitor could dip further in the next few days,” wrote John Schlegel, JPMorgan’s head of positioning intelligence. However, he cautioned that a strong market rebound would depend on forthcoming macroeconomic data, including ISM manufacturing, PMI data, the consumer price index, and retail sales.

In the thick of Monday’s trillion-dollar selloff, institutional investors showed a notable appetite for U.S. stocks, purchasing $14 billion in shares, according to JPMorgan’s analysis. This activity came as a sharp contrast to retail investors, who were net sellers. The professional investors’ return to the market suggests a belief that the recent volatility may be overblown relative to economic data that has yet to signal an imminent recession.

Following Monday's turmoil, the S&P 500 Index rebounded by about 1% on Tuesday, and the Nasdaq 100 Index saw a similar gain. Meanwhile, the Cboe VIX Index and the VVIX Index, which measure market volatility and volatility of the VIX, respectively, both retreated from their highest levels since 2020.

Whether Monday’s gyrations in stocks mark the bottom is uncertain, and concerns remain over the sustainability of spending on artificial intelligence and the Federal Reserve’s timing on interest rate adjustments. However, many hedge funds are framing the current problems as short-term and sentiment-driven, as opposed to long-term issues with the fundamentals of listed businesses or the wider U.S. economy.

Historically, the S&P 500 Index has generated a median return of 6% in the three months following a 5% decline from a recent high, according to Goldman Sachs. However, the team cautioned that the outlook is markedly different when a slump occurs amid resilient economic growth compared to a downturn ahead.

Citigroup Inc.'s strategy team echoed this caution, noting that "recessionary scenarios are by no means priced in." Their bear-market checklist, which tracks metrics such as stock valuations, the yield curve, investor sentiment, and profitability, suggests "buying into weakness" but advises waiting for more evidence of a complete positioning unwind.

Source: Bloomberg, Reuters, Investing.com