Despite growing expectations of US interest rate cuts, hedge funds remain hesitant to buy US equities in early September after becoming net sellers in August. September typically represents a challenging month for market performance.

Data from Lipper indicates that more traditional investors are also showing net selling activity in US stocks, with sell volumes exceeding purchases.

Bank research reports and investment industry sources suggest that while global stock markets remain near historical highs, they still face significant downside risks. Hedge funds have remained cautious and have not participated in recent market rallies.

Here are the specific concerns driving hedge fund caution:

**1. Maintaining a Wait-and-See Approach**

A Goldman Sachs report tracking data through August 25 shows that hedge fund leverage ratios declined significantly in early August and dropped again at month-end.

The S&P 500 Index (^GSPC) closed August with nearly 2% gains and remains close to historical highs, while the MSCI Inc global stock index is at similar levels.

However, Goldman Sachs notes that hedge funds did not participate in August's market gains and continued selling instead, "indicating a more cautious stance."

A Morgan Stanley client report obtained by Reuters on Monday showed that leverage used for trading in US and European markets fell 1% last week, further indicating subdued hedge fund trading activity.

**2. Seasonal Risk Signals**

Over the past 20 years, US stock markets have posted negative returns in September nearly half the time. Due to regulatory reasons, companies are prohibited from repurchasing their own shares in September.

Bruno Schneller, Managing Director at Erlen Capital Management, explains why systematic hedge funds' risk constraints might prevent them from buying during future market declines:

"Seasonally, volatility tends to rise in autumn, and systematic strategies are already running high positions — so the market's 'shock absorption capacity' will be lower than usual."

**3. Market Fragility**

Omar Sayed, Chief Investment Officer at Porchester Capital, suggests that while widespread expectations of Federal Reserve rate cuts in late September make significant US stock outflows unlikely, risks may be lurking in other areas.

The former Millennium Asset Management portfolio manager points out that government bond yields in countries like Japan and the UK have been pushed to multi-year highs, indicating vulnerabilities in other markets.

"If you look at UK 30-year government bonds and Japanese 30-year government bond yield data, you'll find they're at new highs — a crisis in either market could trigger a crisis in another," he said.

In August 2024, the Bank of Japan's unexpected rate hike triggered global selling waves that disrupted equity market trends.

Currently, Japanese 30-year government bond yields hover near recent historical highs above 3%.

**4. Vicious Selling Cycles**

UBS Group AG's Markets and Trading division noted in a Thursday client report that current US equity direct holdings by individual investors (relative to their income) have reached historical highs.

The division estimates that retail investors' direct equity holdings will reach 265% of disposable income in 2025, compared to the previous high of 243% in 2021.

These retail traders account for slightly over 40% of the US equity market.

Erlen Capital's Schneller warns this situation is concerning because signs of significant economic growth slowdown could prompt equity holders to reduce speculative spending, potentially triggering a vicious cycle of stock selling.

"Retail buying power is strong but fragile — when multiple times disposable income flows into the stock market, it may extend the current cycle but also increases the risk of sharp market reversals," he said.

**5. China-Related Trading Dynamics**

Meanwhile, Goldman Sachs data shows Chinese stocks received record net inflows in August.

Morgan Stanley stated in a report last week that August is expected to be the largest month for hedge fund purchases of Chinese stocks since February this year.