JPMorgan: Hedge fund cuts may limit stock declines, chips as risk gauge

JPMorgan's call hinges on positioning, so the crucial question is whether selling dries up even as headlines remain negative. A session of steep chip losses without subsequent forced selling would bolster that view. Momentum-driven investors like commodity trading advisers can rapidly switch from sellers to buyers once trends stabilise, which can trigger sharp rebounds. On the credit side, CoreWeave's bonds and default-protection costs provide the clearest real-time gauge of neocloud funding stress, and any contagion into the debt of larger tech firms would undermine JPMorgan's argument that the issue is containable. Higher bond yields and oil above $110 create a macro headwind, increasing financing costs for capital-intensive AI infrastructure.

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JPMorgan contends that the forced selling in chip stocks is mostly complete, but Thursday's semiconductor sell-off immediately tested that positioning thesis.

Key points:

• JPMorgan strategist Nikolaos Panigirtzoglou stated that hedge fund equity exposure has fallen sufficiently to indicate constrained further downside for equities.
• His team discovered that hedge fund equity performance is tightly correlated with semiconductor shares, and that strict risk boundaries amplified recent chip losses by compelling funds to reduce positions.
• JPMorgan views neocloud funding worries as manageable. It points out that neocloud capex of roughly $80 billion is modest compared with approximately $1.8 trillion in total tech spending this year, and that the tech sector enjoys a financing surplus of around $400 billion.
• Information technology accounts for 28% of the MSCI All Country World Index but absorbs 40% of hedge fund risk capital. For semiconductors, the shares are 13% and 21% respectively.
• The note came out on Wednesday. On Thursday, the Philadelphia semiconductor index dropped nearly 7%, marking its largest daily decline since June, while the Nasdaq fell over 2.5%.

JPMorgan thinks the global stock sell-off may be approaching its end, as hedge funds have already reduced a significant portion of their equity exposure. But the bank's thesis encountered an instant challenge when chip stocks recorded their worst day in four months the day after the note.

In a flows and liquidity note issued Wednesday and covered by Dow Jones MarketWatch, global markets strategist Nikolaos Panigirtzoglou identified a strong correlation between hedge fund equity performance and semiconductor shares, using VanEck's SMH chip ETF as a proxy. The two moved in tandem during the sector's second-quarter rally. When chip stocks started declining, tight risk boundaries compelled funds to cut holdings, exacerbating the drop.

The extent of that de-risking is key to JPMorgan's outlook. The team contends that most of the long positioning in the sector has now been liquidated, including by momentum-driven players like commodity trading advisers, who represent a substantial portion of daily volume. The strategists concede that near-term headwinds persist, but they argue the positioning shift should help cap additional declines.

The note also tackled worries about neoclouds, the specialist firms that lease computing capacity for AI tasks. Their financing has faced increased scrutiny following CoreWeave's troubles and a poorly received IPO in South Korea. JPMorgan does not think those issues will disrupt the AI investment cycle. It argues that computing demand is robust enough for providers to pass on higher funding costs to clients. It also points out that neocloud capex of roughly $80 billion this year is small versus about $1.8 trillion in total tech capex, allowing larger hyperscalers with easier access to capital to fill gaps. And it notes that the broader tech sector generates roughly $400 billion more in cash flow than it spends on capex this year.

The note's most forceful point is about the outsized influence of chip stocks. Information technology makes up 28% of the MSCI All Country World Index by market cap, yet consumes 40% of hedge fund risk capital. For semiconductors, the figures are 13% of index weight and 21% of risk capital. In JPMorgan's assessment, that makes chipmakers the premier single indicator of global risk appetite, since a shift in the sector impacts a far larger proportion of investor capital than its index weight would imply.

That sensitivity was evident on Thursday. The Philadelphia semiconductor index tumbled almost 7%, its largest one-day loss since late June, and the Nasdaq slid over 2.5%, its sharpest drop since early June, per Reuters. The catalyst was a slate of AI-related earnings that reignited worries over expenditure. A supply caution from chip equipment maker Lam Research and a downgrade of CoreWeave added to the pressure.

Not all agree with JPMorgan's equanimity on neocloud funding. CoreWeave's unsecured debt yields have risen to roughly 15%, a level typically signaling financial strain. HSBC has flagged structural issues across the neocloud space, whereas Goldman Sachs contends that CoreWeave's use of asset-backed financing caps the increase in its borrowing costs.

The coming trading sessions will indicate whether Thursday's decline was a final wave of forced selling or the beginning of a fresh downturn. If chip trading stabilizes without additional significant de-risking, JPMorgan's positioning call will appear well-timed. If funding stresses extend beyond the weakest neocloud balance sheets, the cash buffer that the bank emphasizes will probably face a test.