Castle Securities: The market's deleveraging phase is approaching its end, and systemic funds may reallocate to U.S. stocks.

After the large-scale deleveraging at the end of July, some institutions on Wall Street believe that systematic capital is preparing to re-enter the stock market. Citadel Securities stated that as market volatility decreases and stock correlations approach historical lows, the next significant mechanical capital flow of systematic strategies may shift from "deleveraging" to "re-leveraging." At the same time, retail funds, passive ETF investments, and corporate stock buyback demands are all strengthening. Data from Goldman Sachs and Morgan Stanley shows that hedge funds have also returned to being net buyers of stocks, indicating a clear change in market liquidity following substantial position adjustments. Scott Rubner, head of equity and derivatives strategy at Citadel Securities, stated, "The leverage reset process has basically ended, and as volatility declines, the space for systematic strategies to increase risk exposure is forming." He pointed out that the market breadth is currently improving, with correlations among different stocks nearing historical lows. Simultaneously, investors are increasingly willing to pay premiums for further stock market gains, all of which are favorable for the re-entry of systematic capital. Citadel Securities' data shows that the assets under management of leveraged ETFs fell sharply from $218 billion at the end of June to $154 billion in July, a decrease of nearly 42% within a month, reflecting a significant deleveraging that the market has experienced. Among them, the semiconductor sector has seen the most noticeable deleveraging, with related leveraged ETFs currently managing about $31 billion in assets. As this round of position adjustment gradually comes to an end, Citadel Securities believes the direction of market capital flows may reverse. Rubner stated that the next round of significant mechanical capital flow "is likely to be re-leveraging, rather than continuing deleveraging." In addition to systematic strategies, other potential buying pressures are also beginning to strengthen. Rubner noted that individual investors became net buyers of stocks again on the Citadel Securities platform last week, although they are still purchasing downside protection, indicating that while retail risk appetite has rebounded, overall sentiment remains somewhat cautious. Household sectors are currently seeing about $7.5 billion in daily inflows through passive ETFs. Meanwhile, as the U.S. earnings season nears its end, more companies are expected to lift restrictions on stock buybacks ahead of their earnings announcements, which should allow corporate buyback funds to re-enter the market. Citadel Securities' data shows that U.S. companies have been authorized to repurchase their own stock, with an amount exceeding $1 trillion available for this purpose. Rubner stated that this is the highest level recorded for this time of year. This suggests that in the near future, the U.S. stock market may simultaneously receive support from systematic strategies, retail investors, passive investments, and corporate buybacks. The trend of capital flow that Citadel Securities has observed is also corroborated by data from other Wall Street institutions. Data from Goldman Sachs Prime Brokerage indicates that hedge funds recently made their largest stock purchases since November 2020, a significant portion of which comes from short covering. This indicates that some of the bearish positions established during the recent market corrections are being covered, and the short covering itself can create additional buying pressure, further enhancing the momentum for market rebounds. The Morgan Stanley Prime Brokerage team also reported that hedge funds became net buyers of global stocks last week. After undergoing record levels of position unwinding at the end of July, funds have begun to redeploy capital and restore risk exposure. In particular sectors, AI-related stocks have re-emerged as a significant direction for institutional capital inflow. Morgan Stanley noted that in the U.S. stock market, hedge funds are once again increasing their exposure to broadly defined AI-related stocks, and the scale of newly established positions has already surpassed the reductions made from the end of June to July. This indicates that the large-scale deleveraging observed in AI trading is rapidly reversing, with institutional funds beginning to establish related long positions again. Aside from the AI sector, hedge funds have recently also increased long positions in commercial biotechnology, housing, and Real Estate Investment Trusts (REITs). The financial sector has also recorded net buying, which includes alternative asset management firms, banks, and insurance companies. Overall, data from multiple Wall Street institutions shows that following the severe position unwinding at the end of July, the direction of market capital flows has begun to change. Citadel Securities believes that with the decline in volatility, resetting of leverage levels, and reopening of corporate buyback windows, the next phase of market strength is likely to stem from systematic strategies and institutional investors gradually increasing stock exposure, rather than forced deleveraging.