Are Hedge Funds Still Bullish on AI Stocks?

Market Dynamics and Momentum Unwind

• The S&P 500 remained relatively flat while high-beta momentum strategies experienced significant volatility.
• The high-beta momentum basket fell 32% from recent highs, recovering to only a 16% year-to-date gain after peaking above 60% in June.
• The Technology, Media, and Telecom (TMT) momentum long-short pair declined nearly 40% from its highs, marking the sharpest drawdown of the past five years.
• Selling pressure in the technology sector represents the largest supply volume in 10 years, comparable to the summer 2024 episode.
• The composition of selling shifted sequentially: starting with hyperscalers in early June, moving to semiconductor stocks in mid-June, and shifting to hardware components and infrastructure providers by July.
• Hedge funds holding net long positions in global semiconductors reduced their allocation from a record 24% in June to 18% currently, though this remains above the 10% start-of-year level.
• Realized momentum factor volatility surged to its highest level in 45 years (excluding recessions), forcing managers to prioritize de-risking and volatility control over alpha generation.
• Recent market stabilization coincided with increased capital market issuance, index rebalancing, and option expirations over the last six weeks.
• Buying activity is beginning to resurface in the final three trading sessions as the momentum factor stabilizes.

Hedge Fund Positioning and Leverage

• Equity fundamental long-short hedge funds previously held gross exposure at five-year highs and net exposure at four-year highs in early June.
• Post-de-risking positioning now sits near the 65th percentile over the last three years, described as "middle of the pack" rather than washed out.
• The market environment remains highly concentrated, with elevated single-stock volatility and multi-year low stock correlations creating alpha opportunities for single-stock pickers.
• Hedge fund performance averaged a 9% return through the end of June, with all strategies printing positive year-to-date returns, among the best first halves in 20 years.
• Retail investors and leveraged ETFs have significantly increased participation and systemic leverage within the trade, alongside institutional allocation.

Forward-Looking Strategy and Risks

• Current market sentiment favors buying the dip in U.S. AI infrastructure equipment names, citing valuations near two-year lows.
• Goldman Sachs suggests utilizing limited-loss structures, such as cost spreads in the options space, to capture this opportunity amidst high volatility.
• The primary focus for the upcoming earnings week is on mega-cap tech hyperscalers' capital expenditure trajectories and their ability to translate spend into incremental revenue and profit growth.
• A key risk factor to monitor is the potential re-escalation of stock correlations, as the market currently prices them as low despite a "textbook de-grossing" where AI long positions and macro hedges have been reduced simultaneously.
• The analyst views the recent correction as a healthy reset driven by risk management rather than a loss of fundamental conviction in the AI cycle.