Potential equity sell-off looms as trend-following hedge funds brace for market retreat

In the wake of recent market volatility, trend-following hedge funds, also known as CTAs (commodity trading advisers), are poised to offload substantial holdings in U.S. equities, according to a recent note from Goldman Sachs. Should the stock market continue its retreat, these funds could sell between $20 billion and $42 billion in U.S. equities over the next month.

Trend-following hedge funds operate systematically, leveraging algorithms to capitalise on significant market trends. Goldman Sachs highlighted that a pivotal point lies in the S&P 500 index, with a drop below 5,135 points potentially signalling a shift from a positive to a negative short-term trend among these funds, prompting significant equity sales.

According to the bank's analysis, a 3.2% decline in S&P over the next month could trigger approximately $20 billion in sales of companies within the index, extending to over $200 billion in global equities. Should the retreat deepen, the total sell-off in S&P could reach $42 billion.

Various factors, including stronger-than-expected U.S. economic data and renewed geopolitical tensions, have contributed to the recent market downturn, with the S&P experiencing a 2.6% decline since April 11. Against this backdrop, hedge funds have been net sellers of U.S. equities for two consecutive weeks, mainly reacting to surprises in the consumer price index data, which have raised uncertainty regarding potential shifts in Federal Reserve interest rate policy.

For the third consecutive week, Goldman Sachs observes a sustained interest among hedge funds in Chinese equities, with net buying. Conversely, hedge funds have been net sellers of U.S. energy stocks, reflecting shifting investment strategies amidst evolving market conditions.

As market participants closely monitor economic indicators and geopolitical developments, the potential sell-off by trend-following hedge funds underscores the significance of algorithmic trading strategies in shaping market dynamics. With the interplay of various factors influencing investor sentiment, the coming weeks may witness further adjustments in hedge fund portfolios as they navigate evolving market trends and uncertainties.