Are Hedge Funds Right to Be Cautious on U.S. Stocks This September?

As markets approach a traditionally volatile September, hedge funds are showing significant reluctance to engage in the U.S. stock rally. Despite the potential for a forthcoming U.S. rate cut, many hedge funds have opted to sell rather than buy, indicating a cautious stance amid rising yields and a backdrop of fragile market conditions.

Last updated: 02 September 2025 (BST)

Key Takeaways

• Hedge funds have become net sellers of U.S. stocks, reflecting a cautious approach.
• Leverage levels among hedge funds have dropped, suggesting muted trading activity.
• September historically sees negative returns in U.S. stock markets.
• Rising bond yields present potential risks to equity markets.
• Retail stock holdings are at an all-time high relative to disposable income, increasing market fragility.
• Chinese equities are experiencing significant inflows, contrasting the U.S. trend.

Hedge Funds' Cautious Stance

The recent behaviour of hedge funds signifies a marked shift in sentiment. According to a Goldman Sachs report, hedge funds have refrained from participating in the stock market rally seen in August. Instead, they have continued to sell off their U.S. equity positions. This trend raises questions about the overall health of the market and the potential for a downturn.

Declining Leverage Levels

One of the primary indicators of hedge fund activity is their leverage, or borrowing levels. Recent data reveals that hedge fund leverage has dropped again, following a significant reduction earlier in August. Morgan Stanley noted a 1% decrease in leverage used for trades in both the U.S. and Europe, suggesting that hedge funds are adopting a more conservative approach to trading.

Seasonal Market Trends

September has historically been a challenging month for U.S. equities, with negative returns occurring in approximately half of the last 20 years. One contributing factor is the prohibition on corporate stock repurchases during this month due to regulatory restrictions. Bruno Schneller, managing director at Erlen Capital Management, highlighted how systematic hedge fund strategies might limit buying opportunities during this time, potentially exacerbating market volatility.

Impact of Corporate Buybacks

Corporate buybacks serve as a stabilising force in the equity markets, helping to support stock prices. When these buybacks are absent, the market can experience mixed returns. Schneller emphasised that the lack of corporate repurchases combined with stretched hedge fund positions could lead to less market resilience against shocks.

Market Fragility and Bond Yields

Current market conditions are further complicated by rising bond yields. With government bond yields in countries like Japan and the UK reaching multi-year highs, analysts are expressing concern over broader market weaknesses. Omar Sayed, Chief Investment Officer at Porchester Capital, stated that any crisis in one market could trigger a ripple effect across others, highlighting the interconnected nature of global financial systems.

Historical Context of Bond Yields

For instance, Japan's 30-year government bond yield is trading above 3%, a level not seen in years. This trend is significant, as it follows an August 2024 global sell-off triggered by an unexpected rate hike by the Bank of Japan. Investors are wary that similar conditions could arise again, creating additional pressure on U.S. stocks.

The Vicious Circle of Selling

The current landscape is characterised by a high level of direct stock ownership among retail investors, who now hold a record amount of equities relative to their income. UBS estimates that by 2025, retail stock holdings will reach 265% of disposable income, surpassing the previous high of 243% recorded in 2021. This overexposure creates a precarious situation; a slowdown in economic growth could lead to increased selling pressure from these retail investors.

Retail Investor Dynamics

Retail traders account for over 40% of the U.S. stock market, making their actions influential. As Schneller pointed out, while the retail bid for stocks is powerful, it is fragile, especially when multiples of disposable income are heavily invested in equities. This situation raises the risk of a sharp market unwind should economic conditions shift unfavourably.

Contrasting Trends with Chinese Equities

While U.S. hedge funds exercise caution, the trend appears to be different in Chinese equities. August 2025 marked a record inflow of investments into Chinese stocks, as reported by Goldman Sachs. Morgan Stanley noted this period as the largest monthly buying spree of Chinese shares by hedge funds since February, indicating a divergence in market sentiment between the U.S. and China.

Reasons for Interest in Chinese Markets

Investors may be attracted to Chinese equities due to perceived growth opportunities or a more favourable regulatory environment. As the global economic landscape evolves, hedge funds may continue to reallocate their investments, seeking out markets that demonstrate resilience or potential for recovery.

What Comes Next for Hedge Funds and Markets?

As we look ahead, the combination of cautious hedge fund behaviour, rising bond yields, and historical patterns of market performance in September raises questions about the sustainability of the current market rally. With expectations of a potential U.S. rate cut, investors are weighing the implications for both equities and fixed income.

Market participants should remain vigilant for signs of volatility and shifts in investor sentiment. The delicate balance between retail and institutional investors, along with geopolitical factors, will likely shape market dynamics in the coming months. As the financial landscape continues to evolve, the future of both U.S. and global markets hangs in the balance.

FAQs

Why are hedge funds hesitant to buy U.S. stocks now?

Hedge funds are cautious due to declining leverage levels, rising bond yields, and historical trends indicating that September can be a volatile month for equities.

What impact do corporate stock buybacks have on the market?

Corporate stock buybacks support stock prices by reducing the number of shares available, stabilising the market. Their absence can lead to mixed returns and increased volatility.

How do rising bond yields affect equity markets?

Rising bond yields can signal market fragility and may lead to increased selling pressure in equities, as investors reassess risk and seek better returns elsewhere.

What is the significance of retail investors in the stock market?

Retail investors now hold a significant portion of the stock market, influencing price movements. Their high levels of stock ownership relative to income increase market fragility and vulnerability to downturns.

What are the implications of increased investment in Chinese equities?

Increased investment in Chinese equities suggests a shift in investor confidence towards markets perceived as having better growth prospects, potentially impacting global market dynamics.