Citadel Securities: Market Deleveraging Phase Nears End, Systematic Funds May Reallocate to U.S. Stocks

According to Zhitong Finance APP, after the large-scale deleveraging at the end of July, some Wall Street institutions believe that systematic funds are preparing to increase their equity exposure again. Citadel Securities stated that as market volatility declines and stock correlations approach historical lows, the next major mechanical flow of systematic strategies may shift from "deleveraging" to "releveraging."

Meanwhile, retail funds, passive ETF funds, and corporate stock buyback demand are all increasing. Data from Goldman Sachs and Morgan Stanley shows that hedge funds have once again become net buyers of stocks, indicating a significant shift in market liquidity following prior large-scale portfolio adjustments.

Scott Rubner, Head of Equities and Derivatives Strategy at Citadel Securities, said, "The process of resetting leverage is basically over. As volatility decreases, there is now space for systematic strategies to rebuild risk exposure."

He pointed out that market breadth is currently improving, stock correlations are near historic lows, and investors are increasingly willing to pay a premium for further stock market gains. All these factors are favorable for systematic funds to re-enter the market.

Citadel Securities data shows that the assets under management of leveraged ETFs plummeted from $218 billion at the end of June to $154 billion at the end of July—a single-month drop of nearly 42%—reflecting significant deleveraging in the market.

The semiconductor sector saw the most pronounced deleveraging, with leveraged ETFs in this area now managing around $31 billion.

As this round of portfolio adjustments gradually completes, Citadel Securities believes the direction of market capital flows may reverse. Rubner stated, "The next significant mechanical flow will likely be releveraging, not further deleveraging."

In addition to systematic strategies, other potential buying forces are also strengthening.

Rubner noted that retail investors became net buyers of stocks on the Citadel Securities platform last week, though they continue to purchase downside protection. This shows that while risk appetite among individual investors is recovering, overall sentiment remains somewhat cautious.

Currently, about $7.5 billion flows into passive ETFs daily through household channels. At the same time, with US earnings season drawing to a close, more and more companies will see the end of their buyback blackout periods, and corporate buyback funds are expected to return to the market.

Cidalel Securities data indicates that U.S. companies now have over $1 trillion authorized and available for stock buybacks, which is the highest level on record for this period of the year, according to Rubner.

This suggests that in the coming period, the US stock market may receive buying support from systematic strategies, retail investors, passive investment funds, and corporate buybacks at the same time.

The capital inflow trend observed by Citadel Securities is also confirmed by data from other Wall Street institutions.

Goldman Sachs Prime Brokerage data shows hedge funds recently conducted their largest round of stock buying since November 2020, with a significant portion of funds coming from short covering.

This indicates that some bearish positions established during the prior market adjustment are now being closed, and short covering itself generates additional buying momentum, further reinforcing the market's rebound.

Morgan Stanley Prime Brokerage team also said hedge funds became net buyers of global equities last week. After the record-scale position unwinding at the end of July, funds have begun redeploying capital and restoring risk exposure.

At the sector level, AI-related stocks have once again become a key direction for institutional capital inflows.

Morgan Stanley noted that in the U.S. stock market, hedge funds are once again increasing their exposure to broadly defined AI-related equities, and the recently rebuilt positions now exceed what was reduced between late June and July.

This means the large-scale deleveraging previously seen in AI trading is rapidly reversing, with institutional funds resuming long positions in the sector.

Besides the AI sector, hedge funds have also been increasing long positions in segments like commercial biotechnology, housing, and real estate investment trusts (REITs). The financial sector also recorded net buying, including alternative asset managers, banks, and insurance companies.

Overall, data from several Wall Street institutions shows that after the sharp position reduction at the end of July, market capital flows have started to shift. Citadel Securities believes that with declining volatility, the completed reset of leverage levels, and the reopening of corporate buyback windows, the next notable source of funds in the market may no longer be forced deleveraging, but rather the resumption of equity exposure by systematic strategies and institutional investors.