The recent sharp correction in the U.S. stock market, especially the steep decline of momentum stocks, has left investors filled with doubts about the future direction of the market.
Morgan Stanley's latest analysis indicates that, based on historical data, this round of selling may have entered the &#34;latter half,&#34; but the most vulnerable speculative areas of the market still face further &#34;de-leveraging&#34; risks, and the short-term outlook is not optimistic.
According to Morgan Stanley's report, since peaking on October 15, the momentum index composed of long and short strategies has fallen by more than 14%.<img src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/96515b63-d720-489e-b9f0-85465c786942.png?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" alt="" original-src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/96515b63-d720-489e-b9f0-85465c786942.png"/>
What is even more noteworthy is that this round of selling led by strong stocks has now lasted for 21 trading days, approaching the historical average duration of about 25 trading days.
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Although the duration suggests that the selling may be nearing its end, the market's technical structure and investor positioning reveal recent vulnerabilities. The report emphasizes that retail investors remain heavily positioned, and the overall &#34;negative gamma&#34; exposure in the options market means that any further declines could be amplified, increasing market volatility.
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This series of signals indicates a short-term divergence in the market: high volatility and speculative stocks may continue to be under pressure, while any pullbacks in broader indices or high-quality momentum stocks due to a market-wide decline could present buying opportunities.
<h2>Selling Pressure Approaching Historical Average Duration</h2>
Morgan Stanley's quantitative strategy team noted in the report that the current depth of the momentum stock sell-off is quite similar to historical patterns. Since the peak, the long position in momentum stocks has fallen by 19%, which is roughly consistent with the historical average decline of -22% during such sell-offs.<img src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/1e0c35cf-8761-4c60-b0d3-8fe11ef82906.png?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" alt="" original-src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/1e0c35cf-8761-4c60-b0d3-8fe11ef82906.png"/>
Although analysts believe the sell-off has entered the &#34;latter half,&#34; it does not mean it has ended. The report specifically mentions that parts of momentum stocks with higher beta coefficients may face more downside potential. In contrast, high-quality AI-related stocks that have also been affected in this rotation are more likely to be viewed as buying opportunities during their pullbacks.
<h2>Institutional and Retail Positions Highly Concentrated, Risks Intensified</h2>
A core risk facing the market is the high concentration of positions among hedge funds and retail investors. According to MS PB Content data, the long leverage level of hedge funds is at the 98th percentile of the past five years, close to the peak since 2006. Additionally, the concentration of their long positions has only slightly retreated from recent highs, remaining at the 87th percentile of the past year
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Despite recent sell-offs by hedge funds in popular sectors such as artificial intelligence and technology, media, and telecommunications, and a shift towards less crowded areas like healthcare, their overall risk exposure has not significantly decreased. The net exposure of hedge funds to momentum stocks remains at the 79th percentile of the past year.
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This highly concentrated long position brings about &#34;asymmetric risk,&#34; and if fund managers continue to reduce overall leverage in line with seasonal trends, it will put pressure on the market.
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At the same time, retail investors' holdings overlap significantly with hedge funds' portfolios, as they also hold large positions in these crowded areas.
<h2>Retail Fund Rotation, Speculative Stocks Under Pressure</h2>
The flow of retail funds is becoming a key factor affecting market structure. Data shows that while the inflow of retail funds is still far above the average level of the past year, the funds are becoming increasingly concentrated. In the past week, nearly half of the retail stock purchases were concentrated in the top ten companies, mainly large tech stocks such as Nvidia (NVDA), Tesla (TSLA), PLTR, and META.
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This means that, with the total inflow of funds remaining unchanged, the funds flowing into smaller, unprofitable speculative stocks are decreasing. This rotation of funds has already impacted the &#34;retail favorite stocks&#34; portfolio, which includes both large tech stocks and speculative themes like Bitcoin miners. Since October 15, this portfolio has underperformed the Nasdaq 100 Index by about 15%. If the inflow of retail funds slows down or remains highly concentrated, even without a large-scale sell-off, speculative and momentum-heavy stocks will continue to be under pressure.
<img src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/aac81c36-3633-4262-b75c-9423d7eba95f.png?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" alt="" original-src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/aac81c36-3633-4262-b75c-9423d7eba95f.png"/>
<h2>Technical Risks Amplifying Market Volatility</h2>
Two technical factors are exacerbating the market's vulnerability.
First is the unprecedented &#34;crowding risk.&#34; Currently, the number of stocks appearing simultaneously in 1-month, 3-month, 6-month, and 12-month momentum long portfolios has reached 45, a highly overlapping situation that has only occurred twice in history (September 2018 and June 2022), and in both instances, momentum stocks continued to weaken in the following 1 to 3 months
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Secondly, the structure of the options market also hides risks. The report points out that due to the growth of leveraged ETF assets under management, the overall market's &#34;gamma&#34; exposure has turned into a net short position. This means that the market's own volatility &#34;shock absorber&#34; effect has been weakened, making the stock market more prone to severe intraday fluctuations. Morgan Stanley estimates that leveraged ETFs currently contribute about $10 billion in short gamma for every 1% decline in the S&amp;P 500 index.
Despite the short-term risks, Morgan Stanley believes that any broad weakness in the market could provide buying opportunities for investors at the index level or in high-quality sectors. Meanwhile, investors can hedge specific risks through derivatives, such as buying put options on a basket of high beta stocks or constructing put spread strategies targeting &#34;retail-favored stocks&#34; to guard against further declines in speculative sectors.
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Morgan Stanley analysis indicates that the current sell-off of momentum stocks is similar to historical patterns, with its long positions down 19% from the peak, close to the historical average decline of 22%. Although the sell-off may have entered its latter half in terms of duration, the market structure remains fragile. Due to the high concentration of positions among institutions and retail investors, combined with technical risks in the options market, speculative sectors still face pressure, while any broad market decline could provide buying opportunities for quality stocks and broad-based indices

- Recent volatility in the U.S. stock market, particularly among momentum stocks, has raised investor concerns about future trends.  
- Morgan Stanley's analysis suggests that while the current sell-off may be in its later stages, speculative areas remain vulnerable to further declines, with a notable drop of over 14% in momentum indices since mid-October.  
- The report highlights concentrated positions among both hedge funds and retail investors, increasing market risk, while suggesting that any broad market weakness could present buying opportunities in quality stocks.

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Morgan Stanley

How much longer will U.S. stocks fall? Historical data shows that after a big rise, the average selling wave lasts for 25 trading days, and it has already been 21 days