Trading insights: U.S. equities: Buy the dip or brace for volatility?

[Music]

Sunny Potharaju: Welcome to Market Matters on J.P. Morgan's Making Sense. Hi, I'm Sunny Potharaju, a U.S. based member of our Positioning Intelligence team. Today I'm really excited to be joined by John Schlegel, head of the Global Positioning Intelligence team here at J.P. Morgan. John, thanks for joining me today.

John Schlegel: It's great to be with you, Sunny.

Sunny Potharaju: So today we'll talk about hedge fund performance last year as well as positioning outlooks both in terms of the near and the medium term for 2025.

John Schlegel: So, Sunny, before getting into some of the positioning setup, I did want to touch on performance and what we're seeing on our team, given you track a lot of metrics for us. There have been a number of news articles suggesting many hedge funds performed very well last year. Can you shed some light on what we saw into the end of the year and what the full year looked like?

Sunny Potharaju: Yeah. So starting with the end of last year, hedge fund performance was strong in November, followed by a small negative month in December as equities were down globally. This was mainly felt by fundamental equity strategies which are traditionally long biased, while more market neutral quants and multi-strats did better. Over the course of the entire year, hedge funds gained close to 10% globally in 2024 compared to the 6% gains we observed in 2023. Each of those equity strategies we mentioned did well over all last year with the average fund seeing high single to low double digit returns, though some did even better. The most interesting part of performance seems to be within the most crowded stocks on our book. We saw longs outperform shorts across regions, which was quite profitable. In North America, crowded longs were up 35% while shorts were pretty much flat, creating a strong, positive spread. For context, spreads in 2021 to 2023 in North America were around 15 to 20%, so last year's 35% spread was very strong. And it wasn't limited to just North America either. Europe and Asia were also regions where crowded longs outperformed shorts by 18 and 43%, respectively.

John Schlegel: That's great, and really good context for how well the crowded stocks did last year. If you dig in a bit further, looking at regions or sectors, is there anything that stands out to you?

Sunny Potharaju: Yes. So starting with regions, something immediately notable for us is the hedge fund performance in Asia was the strongest in 2024. They were up over 11% for the full year in 2024 in line with the MSCI Asia Pacific, and strategy returns throughout the year were strong, led by quants in Asia followed by directional long/short funds. At a sector level, we generally saw positive alpha across all sectors last year. For hedge funds, one key way we try to measure this is by looking at relative performance or spreads between the longs and shorts, similar to what we described for crowding returns earlier. There were a few sectors that really stood out. For example, TMT and consumer discretionary were two areas that generally produced quite strong returns, though most of the spread was driven by the short side. Healthcare, financials, and industrials also did well with longs helping a bit more as they were up in line or more than market benchmarks.

John Schlegel: That's great, Sunny. It generally gives me the sense that while performance was strong in certain areas, there was a breadth of positive gains across sectors, regions, and even strategies to what you mentioned earlier.

Sunny Potharaju: There was. And on that, I've got a question for you. Given you've done this for a while now, what's your view on whether this performance can continue?

John Schlegel: That's a great and somewhat difficult question at the moment. The reason why I say that is that on the one hand, given the market environment and increased dispersion, there is a sense that performance could continue to be strong throughout 2025. However, one of the biggest changes that we saw with the U.S. election is that hedge funds started to add risk back. And by this I mean, they were adding to position on both the long and the sort side, something they hadn't done in the months leading up to the election, presumably due to election risks and higher volatility in markets. Given the amount of gross flows, as we have put it, that have come into the market from hedge funds, it does present a bit of unwind risk given these flows tend to be correlated with hedge fund performance, and in particular their alpha. So over the next couple of months, given the level of performance has been quite strong heading into the end of last year and the flows were quite strong, we do think there's a little bit of subversion risk that, uh, presents itself at the moment.

Sunny Potharaju: Okay, that's interesting in terms of performance. Going forward, what's the near and medium term setup for U.S. stocks from a directional standpoint?

John Schlegel: So I'll start with the medium term setup just to give a bit of backdrop. When we look at an overall positioning setup, and how we ended last year versus how we ended all the other years since 2006, I think the interesting thing is that there are two particularly positive setups that have led to 14 to 20% gains in the following year with no down years. And these are either A, positioning is low, which is what we had at the end of 2022, or B, positioning is trending higher, like we saw at the end of 2023. The trend to avoid is when positioning is high and trending lower. At the moment, none of these conditions exist. We have relatively high positioning but it's been pretty flat. So the setup is somewhat murky. From a more near term standpoint, we think positioning got pretty high about a month after the election across a number of different metrics. And so the pullback that we've seen since early December is not shocking, and at this point we're even seeing the amount of reduction get to a level that's close to what could trigger a more attractive setup. So to put it more specifically, we track four-week changes across our tactical positioning monitor and that's at a negative one standard deviation level. If it were to hit negative 1 1/2 standard deviations, it could indicate a buy the dip opportunity. And overall, we think positioning levels are a bit below their- their prior highs. We got as high as the 95th percentile the middle of last year, we're around the 70th percentile more recently, but not quite at the 50 to 60th percentile levels which marked some of the lows last year.

Sunny Potharaju: That's good to know on the U.S. What about the rest of the world? Anything on Europe and Asia?

John Schlegel: Yeah. So I think the setup is a bit different in Europe and Asia, in that in Europe, there was quite a bit of under performance versus the U.S. And in particular we saw this reflected in hedge fund net exposure in Europe, ex-UK dropping to levels that were inline with early 2021, which also happened to be a relative low for Europe versus U.S. performance at the time. We also see relatively lower exposure among the CTAs or trend following community in Europe, versus the U.S. However, in terms of medium term outlook for stocks, these aren't, in and of themselves, clear, positive signs that we will see European outperformance as a lot really could depend on whether the macrodata improves. In terms of the UK, the rising gilt yields has been catching a lot of attention as the pound has also been falling. And I think from a very midterm standpoint, we have seen this reflected in some of the recent flows with hedge funds selling domestic stocks and buying exporters. However, the positioning setup isn't so light in domestic stocks to warrant unnecessary kind of attractive setup. And then finally, in Asia, the positioning levels on a year-over-year basis definitely increased versus what we saw a year ago. If you think back to a year ago, China and Hong Kong equities had been selling off a lot and positioning had been getting very light there. We've seen that neutralized a little bit, although we don't think investors are particularly bullish on China. And then in Japan we still see relatively high positioning from our hedge fund community, especially in a sector like financials.

Sunny Potharaju: Thank you for that, John. That was really interesting. Any final thoughts for our listeners?

John Schlegel: Yeah. So one thing I just wanna mention before we wrap up is that our market intelligence team in the U.S. still has a positive view on U.S. equities from a tactical standpoint. And really what this comes down to is there's above trend GDP growth and still positive earnings growth. And I think it really does tie-in well to the near term potential by the dip opportunity that we could be setting up for. So if I just think about the summary of what we talked about today, hedge fund performance did quite well last year across many different sectors, regions, strategies but we do think in the U.S. there could be a little bit of near term risk. From a wider lens, we think there could be a buy the dip opportunity for U.S. equities in the near term, but the medium term is a little bit murkier given positioning has been high for a while. The finally, outside the U.S., positioning definitely isn't as high as we see it in the U.S., but the outlook from here, once again will depend likely on a lot of the macro backdrops, which have yet to improve in a material fashion.

Sunny Potharaju: Thanks, John. That's a great summary. Really appreciate your time today.

John Schlegel: Absolutely.

Sunny Potharaju: Thank you also to our listeners from tuning into this bi-weekly podcast series from our group. If you have feedback or you'd like to get in touch with us, please go to our website, jpmorgan.com/market-data-intelligence, where you can send us a message via the contact us form. And with that, we will close. Thank you.

Voiceover: Thanks for listening to Market Matters. If you've enjoyed this conversation, we hope you'll review, rate and subscribe to J.P. Morgan's Making Sense, to stay on top of the latest industry news and trends. Available on Apple Podcasts, Spotify, Google Podcasts, and YouTube. The views expressed in this podcast may not necessarily reflect the views of J.P. Morgan Chase & Co and its affiliates (together “J.P. Morgan”), they are not the product of J.P. Morgan’s Research Department and do not constitute a recommendation, advice, or an offer or a solicitation to buy or sell any security or financial instrument.  This podcast is intended for institutional and professional investors only and is not intended for retail investor use, it is provided for information purposes only. Referenced products and services in this podcast may not be suitable for you and may not be available in all jurisdictions.  J.P. Morgan may make markets and trade as principal in securities and other asset classes and financial products that may have been discussed.  For additional disclaimers and regulatory disclosures, please visit: www.jpmorgan.com/disclosures/salesandtradingdisclaimer. For the avoidance of doubt, opinions expressed by any external speakers are the personal views of those speakers and do not represent the views of J.P. Morgan. © 2025 JPMorgan Chase & Company. All rights reserved.

[End of episode]