JPMorgan Sees Stocks at Risk as Quants and Hedge Funds Pile In

(Bloomberg) -- Human hedge funds are as bullish as their robot competitors -- ringing alarm bells at JPMorgan Chase & Co.

As U.S. stocks flirt with all-time highs, evidence is building that fast-money investors have stretched positions with echoes of the January melt-up.

Hedge funds pursuing long-short equity strategies have record exposure to the S&P 500 Index, judging by the portion of their returns attributable to the benchmark, a measure known as beta.

Meanwhile, returns posted by risk-parity and statistical-arbitrage funds -- two types of quantitative investors -- are ever-more linked to U.S. shares, and near levels notched on the eve of the February correction, according to JPMorgan.

It all raises the danger that the next sell-off will amplified by quants and discretionary hedge funds beating a retreat.

JPMorgan Sees Stocks at Risk as Quants and Hedge Funds Pile In

“Our analysis suggests that institutional investor positions on U.S. equities are rather elevated and not far from last January’s levels,” JPMorgan strategists including Nikolaos Panigirtzoglou wrote in a note on Friday.

The fire-power of the investing cohort suggests caution ahead. Discretionary long-short equity managers alone oversee about $900 billion, according to estimates from the New York-based bank.

JPMorgan Sees Stocks at Risk as Quants and Hedge Funds Pile In

Risk-parity managers, meanwhile, who slice and dice exposures across assets to juggle volatility, are estimated to hold anything between $120 billion to $500 billion.

The other quantitative faction JPMorgan notes for their high exposures: relative value multi-strategy funds, which aim to arbitrage statistically significant relationships between various instruments.

JPMorgan Sees Stocks at Risk as Quants and Hedge Funds Pile In

Not all metrics are signalling extreme sentiment.

Some hedge-fund books tracked by prime brokers capture weaker risk appetite. Clients on Morgan Stanley’s platform have reduced net leverage to 49 percent, down from a peak of 60 percent in March.

And JPMorgan points to another source of comfort when tracking the quantitative cohort: Trend-followers’ equity exposures are relatively muted at around two-thirds of their January peak. Meanwhile, the mom and pop crowd are playing defense.

“August and September to-date have seen modest outflows from equity funds and inflows into bond funds, suggesting that retail investors retain a rather cautious stance,” the strategists wrote.

Still, with short interest on American stocks on the decline while volatility traders bank on subdued price swings, signs of U.S. equity-market "vulnerability” are building, JPMorgan concludes.

©2018 Bloomberg L.P.