Hedge Funds in Retreat: The Market's Margin Call Crisis

The financial world is in turmoil. Hedge funds, once the darlings of Wall Street, are now in retreat, capitulating to the relentless selloff that has gripped global markets. The catalyst? Former President Donald Trump’s sweeping tariff policies, which have sent shockwaves through the economy and triggered a wave of margin calls that are testing the resilience of even the most seasoned investors.

The Nasdaq Composite Index, a bellwether for the tech sector, has confirmed a correction from its December peak. Technology, media, and telecommunications stocks—where hedge funds had highly concentrated long positions—have borne the brunt of the decline. The S&P 500’s technology sector has posted an 8% year-to-date loss, making it the second-worst performer after consumer discretionary stocks, which are down over 9%. This selloff has been exacerbated by hedge funds entering the week heavily long on tech and growth stocks, as confirmed by a JPMorgan note.



The market turbulence was fueled by a weakening US economic outlook and uncertainty over Trump’s tariff policies. The Dow Jones Industrial Average futures fell 1,033 points, or 2.68%, pointing to another brutal session ahead on Monday. S&P 500 futures shed 3.34%, and Nasdaq-100 futures lost 4.26% as investors continued to shed their one-time tech winners to raise cash. This follows a market wipeout to end last week, with the Dow posting back-to-back losses of more than 1,500 points for the first time ever, including a 2,231-point shellacking on Friday. The S&P 500 dropped 6% on Friday for its worst performance since the outbreak of the pandemic in March 2020. The benchmark lost 10% in two days, pushing it to more than 17% below its February record, perilously close to a 20% bear market. The Nasdaq Composite entered a bear market Friday—down 22% from its record—after losses on Thursday and Friday of nearly 6% apiece.

The selloff has been vicious, with investors that bet on US exceptionalism and economic might stampeding out of its markets. The benchmark S&P 500 index fell 10.5% over two days and lost about $5 trillion in market value. China's CSI300 blue-chip index fell more than 5% on Monday, while the pan-European STOXX index is down nearly 12% from its March 3 all-time closing high and in correction territory.

The impact of these margin calls is far-reaching. Hedge funds that pursue a long-short equity strategy have been particularly hard-hit as market volatility metrics surged. Analysts at J.P.Morgan estimated net leverage, which refers to borrowing, by hedge funds fell between 5% and 6% last week over the previous one, and that net hedge fund leverage could be around the lowest since late 2023. The bank said on Friday that volatility targeting portfolios had between $25 billion and $30 billion in equities to sell in the coming days, as they unwind positions to reduce risk. Levered exchange-traded funds (ETFs) had an additional $23 billion to sell to rebalance into Friday's close, mostly tech stocks, it had said.

The rush for cash has seen even gold, typically a safe asset during crises, fall sharply since Trump's "Liberation Day" tariffs were unveiled on April 2. "In market selloffs like this, panic and forced selling via margin calls can dominate for a while," said David Seif, chief economist for developed markets at Nomura in New York. "That’s not to say that it isn’t based on a very real negative event, which is these tariffs. But I think the ensuing selloff can take on a life of its own."

The potential long-term effects of hedge funds liquidating their positions on the tech and growth sectors are significant and multifaceted. The liquidation of these positions by hedge funds could lead to a prolonged period of underperformance in the tech and growth sectors. As hedge funds offload their holdings, the demand for these stocks decreases, which can drive down prices further. This could create a self-reinforcing cycle where falling prices lead to more selling, as investors seek to cut their losses or meet margin calls.

Moreover, the shift in investment strategy from tech and growth to more defensive sectors could influence future market trends. As hedge funds reduce their exposure to risky assets, they may increase their holdings in sectors that are less sensitive to economic downturns, such as utilities, consumer staples, and healthcare. This sector rotation could lead to a reallocation of capital away from growth-oriented sectors and towards more stable, dividend-paying stocks.

The liquidation of hedge fund positions could have broader implications for market volatility and liquidity. As large institutional players unwind their positions, price swings tend to become more pronounced, creating both challenges and opportunities for traders. The CBOE Volatility Index, Wall Street's fear gauge, closed Friday at the 45 level, an extreme level seen mostly only during bear markets. This increased volatility could lead to a more cautious investment environment, where investors are more risk-averse and less willing to take on leveraged positions.

In summary, the liquidation of hedge fund positions in the tech and growth sectors could have long-term effects on market trends, including prolonged underperformance in these sectors, a shift towards more defensive investments, and increased market volatility. These changes could reshape the investment landscape and influence future market trends, as investors adapt to a more uncertain and risk-averse environment.