Hedge Funds Short U.S. Equities Amid Tariff Uncertainty

In the wake of recent tariff policies that have caused significant market volatility, many hedge fund managers have chosen to remain cautious, avoiding any substantial bets. However, there is one notable exception: a consensus among these managers to short U.S. equities. This strategy reflects a broader sentiment of uncertainty and a lack of clear direction among global hedge funds, as they navigate the complex landscape shaped by tariff policies. The decision to short U.S. stocks is seen as a hedge against potential market downturns and economic instability, driven by the ongoing trade tensions and their impact on global markets.

According to data provided by Bob Elliott, a former executive at Bridgewater Associates, market confidence—measured by hedge funds' conviction in pursuing specific investment strategies—has been recovering after hitting near multi-decade lows. However, the overall positioning in major asset classes, including currencies, bonds, and commodities, remains weak, with holdings in these areas falling to the lowest levels since 2000. Elliott's firm, Unlimited, tracks the real-time data of approximately 3,000 hedge funds managing around $5 trillion in assets.

Elliott noted that the only significant change in April was the increased shorting of U.S. stocks by hedge funds, despite recent market rebounds. He emphasized that fund managers are now more focused on policy actions rather than rhetoric, and the current policy environment is largely negative. Elliott believes that economic weakness could be a more critical issue than short-term statements from political figures.

The overall cautious stance reflects the high level of uncertainty in the policy environment. The recent imposition and subsequent delay of comprehensive tariff measures by the U.S. administration have exacerbated trade tensions, leading to a reduction in holdings by Wall Street professionals. While retail stock traders have adopted a buy-the-dip strategy, institutional investors, often referred to as "smart money," are increasingly preparing for further declines, at least in the U.S. market.

Elliott explained that operating in such an environment is challenging for hedge funds. One of their responses to policy volatility is to hold cash as a risk management strategy, allowing for quick adjustments when a clear direction emerges. Unlimited uses machine learning to analyze the overall positions and returns of mainstream hedge fund strategies, constructing portfolios that replicate hedge fund investments, including two actively managed ETFs focused on global macro and multi-strategy returns.

Elliott's research revealed a clear trend: stock long-short strategy managers are reducing their exposure to U.S. equities while increasing their bets on European and Japanese stocks. This contrasts with the period before and immediately after the recent elections, when funds were bullish on U.S. stocks, particularly those benefiting from a growth-friendly environment. However, as the Trump administration's policy priorities became clearer in February and March, fund managers quickly reduced their long positions and shifted to short positions. By April, as market volatility increased, they adopted a more pessimistic stance. Currently, the underweighting of U.S. stocks is at levels seen only during a few periods since 2000, including the financial crisis.

Despite the bearish sentiment towards small- and mid-cap companies, many funds see attractive opportunities in the financial and banking sectors due to improving fundamentals and relatively low valuations. New emerging market investments are also notable, with funds focusing on China's stock market, which saw a 6.3% return in the first quarter, outperforming the overall hedge fund industry's 1.7% return.

Elliott highlighted three significant challenges facing the U.S.: federal policies, including tariffs, could slow economic growth; foreign investor interest in U.S. assets is waning; and policy uncertainty is increasing. He believes these factors are not fully reflected in current market prices. Elliott noted that based on current stock earnings growth expectations and valuations, a slowdown in economic growth is not priced in, despite the recent decline in the dollar, which remains at high levels. U.S. stocks have seen decades of outperformance relative to other developed economies, with only a slight correction. Unless there is a significant policy shift from the current administration, these trends are likely to persist.