In the past few years hedge funds as a group have had wild swings in their net equity exposure levels. While there is no way to know the exact numbers, I have seen surveys that showed numerous swings of 20% to 30% in their net equity exposure. On a base of over a trillion dollars that is a lot of movement. Not surprisingly those swings coincided with movements in the market in the same direction.
Mutual funds might control more assets than hedge funds but changes in equity exposure are a lot smaller and happen at a glacial pace, so the effect of their equity allocation on the overall market is minimal. Individual investors have in large part shied away from the market. That leaves hedge funds as having the largest influence on the short term direction of the market.
Since May the buzzword in the hedge fund world has been de-risking and hedge fund surveys and performance have served to confirm that hedge funds have indeed been doing that. But when the market participants with the largest influence have already sold, who is left to sell?
The fact that hedge funds have de-risked was the largest reason I was very bullish a little over two weeks ago and the largest reason I am hesitating to go short now. A few readers have focused on my statement that I am careful going short into the holiday season due to the seasonality. But the main reason for my caution is the fact that hedge funds have de-risked. A perceived year end rally would just be a possible excuse for them to justify re-risking.