Dividend Stocks

Stock Market Crash Alert: Hedge Funds Are Betting Against Stocks

Plenty of folks have been calling for a stock market crash for years. Of course, we haven’t really gotten one, and outside of a couple of blips over the past 15 years (the pandemic and the 2018 taper tantrum), there hasn’t been much in terms of downside volatility to speak of.

That said, similar recession indicators are flashing red, as we saw heading into the pandemic. The steeply inverted yield curve, which has been inverted for quite some time, is starting to re-invert. This so-called bear steepening of the curve has predated all recessions in recent history, so if you’re a person who believes the “this time is different” mantra invites ridicule, now’s the time to start laughing at many top economists who are calling for a “soft landing.”

That’s the view of many hedge funds, at least. Recent reports indicate that hedge funds are taking a much more bearish approach to equities as Treasury yields rise on the longer end of the curve. A report from Goldman Sachs’ brokerage unit highlighted some interesting data, which showed significant short positions from major hedge funds concentrated in specific single stocks.

Let’s dive into what to make of this report and how investors may want to position themselves.

Worries About a Stock Market Crash Pick Up

Bond investors and hedge funds are often the first places retail investors look when they’re searching for “smart money” investors. These are the highly-paid folks with teams of analysts looking to find any sort of inefficiencies in the market. In most cases, if there’s an inefficiency out there, these are the folks who will spot and exploit that opportunity.

Thus, when hedge funds move in a similar direction and begin shorting specific stocks, investors take note. Higher short positions also means hedge funds have less leverage available to them to amplify their long exposure. In other words, hedge funds are choosing to take more risk and hold more cash to offset their short positions. They’re betting that volatility may pick up, scare the market, and make their short positions more profitable.

What does this mean for the average investor? Well, hedge funds are hedging their bets. That’s what they do on any day of the week. However, they’re taking a much more cautious approach to the markets than usual, stoking fears that a crash may indeed be headed our way.

We’ll see how this steepening of the yield curve bleeds through to the headlines in the days and weeks to come. For now, it appears the selloff we’ve seen in the markets over the past three weeks may not necessarily be over yet.

On the date of publication, Chris MacDonald did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Chris MacDonald’s love for investing led him to pursue an MBA in Finance and take on a number of management roles in corporate finance and venture capital over the past 15 years. His experience as a financial analyst in the past, coupled with his fervor for finding undervalued growth opportunities, contribute to his conservative, long-term investing perspective.