Morgan Stanley Quant Warns: Momentum Collapse, Heavy Leveraged ETF Selling Depresses U.S. Stocks With Few Retail Buyers Stepping In

Momentum‑based consensus trades experienced a dramatic reversal on February 5, and Morgan Stanley’s analysis attributes the sharp move to concentrated long‑side de‑risking combined with passive selling from leveraged ETF rebalancing. That combination magnified the decline, while retail participation—ordinarily a stabilizing force during sell‑offs—was notably absent, leaving marginal demand insufficient to absorb the supply.

The sell‑off exhibited a structural pattern characterized by relatively muted index moves alongside intense internal dispersion. Selling pressure was highly concentrated in Nasdaq names and in technology and semiconductor sectors that had been leadership and crowded long themes, including high‑beta areas such as AI, national security plays and Bitcoin mining stocks. By contrast, cyclical sectors, chemicals and banks showed relative resilience, reflecting a clear intra‑market rotation.

Morgan Stanley expects that short‑term technical bounces are possible, but recommends selling into rallies. The firm’s caution rests on the view that the deleveraging and rebalancing dynamics may not yet be complete and that retail flows are likely to remain weak ahead of tax season, making subsequent waves of selling harder to absorb. Historical patterns also indicate that single‑day momentum collapses of this magnitude tend to presage negative returns over the following one to two months.

A defining feature of the episode was the divergence between headline indices and internal breadth. Goldman Sachs observed that at one point nearly three‑quarters of stocks outperformed the S&P 500 intraday even as the index declined, underscoring that the stress was concentrated in a subset of crowded momentum trades. Traders attributed the move more to elevated volatility and technical dislocations than to a single fundamental catalyst. Morgan Stanley’s trading desk described the session as resembling a VaR‑driven rebalancing event, where selling was concentrated in names that had rallied strongly earlier in the year rather than reflecting symmetric long‑short deleveraging.

Quantitative measures showed an extreme one‑day move in momentum indicators. Morgan Stanley reported that its long‑short momentum index MSZZMOMO fell roughly 7.7%—a four‑standard‑deviation event—driven predominantly by weakness on the long side. The momentum long index MSQQUMOL declined about 5.7%, while the momentum short index MSQQUMOS rose only around 1.9%, indicating a one‑sided “cut longs, not shorts” adjustment. Thematic selling focused on previously leading, crowded high‑beta exposures, while more cyclical areas outperformed, producing a rotation away from AI‑centric positions.

Leveraged ETF rebalancing materially amplified the day’s volatility. Morgan Stanley’s quant team estimated that rebalancing flows from leveraged ETFs generated approximately USD 18 billion of selling pressure in U.S. equities, concentrated in Nasdaq, technology and semiconductor names, with several popular stocks experiencing single‑day outflows exceeding USD 100 million. Importantly, this supply shock may persist: with volatility elevated and equity leverage still near the upper end of historical ranges, Morgan Stanley estimates an additional roughly USD 10 billion of potential selling from leveraged ETF rebalancing over the coming week. Continued deleveraging would likely further magnify swings in highly leveraged stocks. The options market structure also contributed to instability; although market‑making desks remained net positive gamma, that exposure had diminished, and when combined with leveraged ETFs’ negative gamma behavior, the market approached a net negative gamma state that exacerbates volatility and selling feedback loops.

Retail demand was conspicuously weak, creating a marginal‑buyer vacuum. Morgan Stanley noted that retail net buying intensity on the day was unusually low—only 16% of trading days in the past year were weaker—and that retail purchases were concentrated in the afternoon rebound. Institutional net selling was unusually strong, with only 11% of days in the past year showing higher institutional selling intensity, primarily during the morning session. The result was a lack of support for consensus long positions at critical moments. Retail weakness also directly depressed momentum factors because retail‑favored names overlap heavily with the stocks used in momentum long and short baskets; when retail demand recedes, momentum strategies are pulled down in tandem. Morgan Stanley further highlighted a seasonal pattern: stocks favored by retail in January historically show negative correlations with returns in February and March, a dynamic often linked to tax‑season liquidity pressures.

Looking ahead, historical evidence suggests caution. Morgan Stanley’s analysis indicates that when the MSZZMOMO index falls 7% or more in a single day with concurrent long‑side weakness of 5% or more, the typical outcome is negative performance over the next one to two months, with median recovery occurring in the third month and a median peak‑to‑trough drawdown near 22%. Within that context, technical rebounds may occur, and some market participants view deep momentum pullbacks as potential medium‑term buying opportunities. Morgan Stanley, however, remains more guarded, emphasizing that positions have not been fully unwound, systemic supply risks remain, and the absence of retail as marginal buyers could make subsequent selling waves more difficult to absorb.