First of all, I am excited to be with 22V and look forward to meeting all of you and seeing how I can help you with market insights, investment ideas related to AI and Bitcoin, and portfolio construction. There is no better time to begin than with a good old hedge fund unwind. Having spent my entire career as a derivatives trader followed by a macro PM and market-neutral hedge fund CIO, I am very familiar with hedge fund unwinds and hope to offer valuable insights today along with views on the future.
Beginning in December, the momentum factor began showing signs that a regime shift might be underway. In my weekly YouTube videos, I highlighted these evolving changes, emphasizing two main warning signs: rising momentum volatility and signs of exhaustion in the trend. For a regime shift to truly occur, investors—particularly hedge funds, which act quickly—need a compelling narrative. Given hedge funds typically manage hedged portfolios, early indicators of macro regime shifts often first appear in equity market-neutral factors.
Catalysts for regime shifts usually emerge from unexpected monetary or fiscal policy changes. The last significant shift occurred in November 2022, when the Fed pivoted from its aggressive rate-hiking cycle. Shortly thereafter, in early December, China finally departed from its zero-COVID policy. Most importantly, ChatGPT was launched, marking the beginning of the AI revolution. These three events, occurring within weeks, initiated what became known as the AI trade. However, China’s reopening ultimately disappointed, and global manufacturing suffered. Starting in November 2022, the U.S. PMI remained below 50 for two consecutive years. Market returns were driven predominantly by the capital-light technology sector led by the Mag7, while capital-intensive and interest rate-sensitive manufacturing companies struggled, creating a concentrated market dynamic. Investors are driven by returns, so when market returns become concentrated, positioning becomes crowded, and abrupt regime shifts cause significant pain as the door to unwind becomes very narrow.
For this current regime shift, there has also been a chain of events. It started on Inauguration Day. As optimism over the new pro-business administration was high, we experienced the “DeepSeek” moment. Out of nowhere, with Nvidia near $150, thematic factors related to AI took a sharp hit. Momentum favorites in AI winners versus losers, power, data centers, cyber, and the Mag7 all took abrupt hits, causing losses. Then, on February 12, we saw a surprise jump in inflation from the CPI report. Initially, there was not a strong reaction within factors. However, within a week, optimism about the new administration’s policies began to fade due to uncertainty around tariffs—especially regarding timing. Instead of growth with hopes of declining inflation, economic data showed softer growth combined with the large January CPI print and rising tariff fears, causing investors to fear stagflation. We observed a rise in momentum volatility and the beginning of a sharp downward move. Crucially, we saw a dramatic change in two other important market-neutral factors: 3-month EPS Revision and Trade Activity. These represent the outlook on growth and stocks with the highest trading volumes. Critically for the autopsy of this hedge fund unwind, the SPX made its last all-time high on February 19th, after all these factors had begun to fall sharply.
This indicated growing uncertainty about whether investments aligned with the previous trend still offered favorable risk-reward profiles. With increasing doubts surrounding economic and AI growth, the regime shift escalated into a broader factor and macro unwind. These developments highlight a significant shift in investor sentiment triggered by greater policy uncertainty. Initially optimistic due to a pro-business Trump administration, investors have grown increasingly cautious as trade policies explicitly shifted toward tariffs. Uncertainty around the precise nature and impact of these tariffs was amplified by recent inconsistent statements from the White House on the actual start date and goods to be impacted, intensifying investor fears. Even Zelensky’s Oval Office meeting added to the unwinds. On the back of that failed meeting, Germany announced a major increase in defense spending, causing the largest daily rise in 10-year yields in over 30 years. Europe had already been outperforming the U.S. this year, but now a weakening U.S. growth outlook combined with a strengthening EU outlook exacerbated the regime shift.
Last week, public communications from the administration worsened. President Trump said there would need to be short-term pain, echoing Fed Chairman Powell’s remarks at Jackson Hole in 2022, which preceded a 17% fall in the SPX into the lows. Treasury Secretary Bessent, who surely knows the importance of certain market vocabulary, emphasized there is no “Trump Put.” This clarification heightened anxiety, magnifying market volatility. Hedge funds, previously positioned for robust business growth and a favorable regulatory environment, have had to swiftly readjust their portfolios. These rapid reallocations have intensified volatility across various asset classes and investment factors, drawing significant media attention to hedge fund performance at a time when there has been heightened focus from the Financial Stability Board on the basis trade. Critically, this regime shift occurred when hedge fund leverage, measured by most metrics, was near its highest levels in the past five years.
When a regime shift happens and hedge fund losses follow, I always focus on three components to determine when the unwinds will end and risk-taking will begin again. First, what the charts are saying—I believe the market always anticipates outcomes. Second, what it will take to change the narrative. Third, a poker analogy: What is the “chip stack” of hedge funds?
Currently, charts are not favorable, suggesting Mag7 leadership has ended and that we will need more time to digest the regime change. SPX breadth, global stock returns, financial stock relative performance, and credit remain strong despite market weakness, suggesting this is a rotation rather than an economy headed for recession. Changing the narrative, in my opinion, is straightforward. As you read my research in the coming months, you’ll see my strong belief in how AI will profoundly impact macroeconomics and companies through productivity and efficiency gains. We are at an inflection point, and although traditional economic statistics might struggle to measure these gains, corporate profit margins and earnings will reflect them. The structural side of the economy and markets is in good shape. All that’s needed for narrative clarity is certainty regarding tariffs and spending cuts—with tariffs being most critical. However, this clarity seems weeks to months away. The “chip stack” for hedge funds remains solid for now because it’s early in the year, but expect defensive positioning for the remainder of this month. Credit is the key indicator to watch, signaling deleveraging severity.
Overall, the good news is sentiment has weakened significantly, and positioning has decreased, so there is cash to put to work at some point. Given we have hit the 200-day moving average in the SPX and approached a 20% correction for the Mag7, I expect at least a temporary market bounce to ease pressure. However, with April 2nd now known as reciprocal tariff day, sustained risk-taking appears unlikely as we head into earnings for Q1. Based on economic data, consumer confidence surveys, and the Beige Book highlighting a freezing of risk-taking at the consumer and company level while waiting for policy clarity, I believe we remain at risk for further hedge fund unwinds over the next couple of months. Watch those crowded positions.
