Retail Greed Surges as Smart Money Exits, Signaling Market Risks

As the market sentiment shifts from "fear" to "greed," retail investors are displaying heightened speculative enthusiasm, with the "MeMe stock basket" compiled by Goldman Sachs surging to record highs. Analysts suggest that when hedge funds, often referred to as "smart money," short stocks while retail investors go long, the stock market typically underperforms in the next one to three months. Currently, "smart money" is showing a clear lack of interest in stocks, with their sensitivity to returns on the S&P 500 index dropping to near-zero levels.

As retail investors become increasingly greedy, "smart money" is quietly exiting the market. Recently, a macro strategy expert published an analysis delving into a concerning trend in the stock market. By tracking the movements of "smart money," the expert revealed that beneath the surface of a seemingly thriving U.S. stock market, risks are accumulating.

The analysis indicates that despite the apparent rise in U.S. stocks, hedge funds, represented by macro funds and quantitative funds, have shown a noticeable lack of interest in stocks. This shift typically signals a future decline in market returns. Meanwhile, overall market sentiment has transitioned from "fear" to "greed," with retail investors exhibiting high speculative enthusiasm. The expert warns that the current market environment is fragile. As stated, "It is precisely because greed is seeping into this rebound that we should pay special attention to the caution of 'fast money.' This greed is often unsustainable, and historical data shows that when greed dominates, the stock market typically underperforms in the next one to three months."

Historical data shows that when macro funds and CTA funds, which are considered "smart money," short stocks while retail investors go long, it historically indicates that the stock market will perform poorly in the next one to three months. Specifically, under these conditions, the average returns for the S&P 500 index over the next one, two, and three months are -0.1%, 0.2%, and 1.6% respectively, all significantly lower than the historical average returns of 0.7%, 1.4%, and 2.3% for the same periods.

On a deeper level, the reason these funds are cautious is precisely because greed is seeping into this rebound. The expert emphasizes that it is the emergence of greed that makes us pay special attention to the cautious attitude of "fast money." This emotional shift can be observed from multiple dimensions: speculative stocks are surging, with the "most shorted stock basket" compiled by Goldman Sachs rising at a record pace. Simultaneously, the bank's "speculative trading indicator," which tracks meme stocks, loss-making companies, and high P/S ratio companies, has risen to its highest level in over three years.

In the options market, sentiment has shifted from the initial "fear" (investors using put options to hedge downside risk) to the current "greed." The expert defines the "greed mechanism" as out-of-the-money call options outperforming out-of-the-money put options, with the VIX fear gauge declining. Historically, "greed rarely ends well, and once it dominates, the stock market typically underperforms in the next one to three months."

Another concerning sign is the complacency that is brewing. The expert warns, "Unlike greed, complacency is not one of the seven deadly sins, but in the market, it should be." Collective overconfidence is the source of many market declines. A clear indicator is the decline in short-term implied volatility relative to long-term implied volatility, which can be measured by the VIX/VXV ratio (VIX measures 30-day volatility, VXV measures 90-day volatility). When this ratio rises rapidly, it indicates that the market believes "risks are in the future, but not today." This mindset, when taken to extremes, is often associated with short-term market reversals.

More alarmingly, this calm volatility is not limited to the stock market. The expert points out that the cross-asset volatility, covering stocks, bonds, credit, foreign exchange, and oil, is declining across the board. This suggests that the market has not been left with any "scars" from some truly unprecedented events that have occurred in recent months, such as trade wars.

The analysis also delves into a technical but crucial concept: the implied correlation of stocks. This indicator measures the degree of coordination among individual stocks in the S&P 500 index. When correlation is low, it means that stocks are moving more independently rather than in unison. The expert explains that during stable market conditions, low correlation artificially suppresses the VIX index. However, once the market starts to decline, stocks tend to move more in sync (in extreme cases, investors sell everything, and correlation approaches 1). At this point, correlation will quickly rise, driving the VIX index higher, which in turn triggers further selling, creating a vicious cycle. Therefore, the current low correlation acts as a potential "downside accelerator."

Interestingly, the analysis also provides a reverse perspective. According to data from a securities firm, CTA funds appear to have just abandoned shorting, with their long positions reaching the highest level in at least three years. The expert acknowledges that the indicators used to analyze fund movements have some lag, and macro and quantitative funds may have re-established long positions in the past one or two weeks. However, this chasing behavior itself carries significant risks. The expert issues a clear warning: given the poor returns of these funds in the past, if they are now hastily chasing this "stubborn" rebound, they had better hope they are right this time.