US stocks still have room for "deleveraging," JPMorgan: three months needed to return to pre-April levels

Original Author: Long Yue

Original Source: Wall Street CN

The shadow of U.S. stock market deleveraging has not yet dissipated.

According to Flow Trader, JPMorgan's Global Market Strategy team stated in its latest report released on July 15 that the investor deleveraging process that began in the U.S. in June is still ongoing. There is further room for deleveraging in three areas: levered stock ETFs, the options market, and margin accounts, which will continue to suppress equity market performance in the coming months.

They estimate that it will take about three months of choppy trading for the ratio of levered stock ETF assets to their underlying market capitalization to return to pre-April levels.

Levered ETFs: Self-Correction Mechanism Activated, But a Long Road Ahead

The problem with levered stock ETFs is essentially a mathematical trap.

The bank explained the logic: assume an underlying index falls 10% one day and rebounds 11.1% the next day to return to its original level. A 3x levered ETF would lose 30% on the first day and gain 33.3% on the second, resulting in a net loss of 7%. In other words, a volatile market itself erodes the scale of levered ETFs, acting as a built-in "self-correction" mechanism.

Data has confirmed this. Analyst data shows that since its peak, the size of the levered memory chip stock ETF has shrunk by 34%, and the size of all levered stock ETFs has shrunk by 13%.

However, the issue is that the decline in the ratio relative to the market cap of the underlying stocks has been much smaller.

JPMorgan analysts pointed out that the ratio of the memory chip stock levered ETF's size to its underlying market cap is three times the average for all stock ETFs, which explains why memory chip stocks are much more volatile than the broader market. More concerning is that even for the overall levered stock index ETF, this ratio is at a high level relative to its own history, indicating this is not just a sector-specific issue but a systemic risk for the entire market.

Analysts judge: "It will take about another three months of a range-bound market for the ratio of levered stock ETF size to underlying market cap to return to pre-April levels."

Furthermore, new capital continued to flow into levered ETFs in July, further extending the time needed for deleveraging.

Options and Margin Accounts: Two 'Minefields' for Retail Investors

In the options market, the retail bullish call buying indicator tracked by JPMorgan analysts (based on OCC data, counting customers holding fewer than 10 contracts) peaked at nearly 14 million contracts on June 5, matching historical highs from October 2025 and November 2021.

Historical patterns show that each time this indicator peaks, tech stocks experience a multi-month correction, with the bottom typically occurring when the indicator falls to a low of 2 million to 4 million contracts. While the indicator has clearly retreated from its peak, analysts believe that if it ultimately falls to a 'capitulation' level of 2 million to 4 million contracts, tech stocks will still face sustained pressure.

The situation is more severe for margin accounts. Using the NYSE Net Debit Balance as a proxy for U.S. individual investor leverage, analysts showed the current level is at an extreme historical high, comparable to peaks seen in late 2021 and mid-2018—and after those peaks, the stock market experienced multi-month corrections.

Analysts noted some recent signs of a pullback in margin account leverage, but "significant further deleveraging is still needed before it ceases to be a major headwind for the stock market."

In contrast, leverage from risk parity funds has largely normalized and is no longer a major source of market resistance.

Hedge Funds: Semiconductor Exposure May Have Quietly Shrunk

At the hedge fund level, JPMorgan's data shows an interesting shift.

In June, despite the S&P 500 and Nasdaq indices falling, Equity Long/Short hedge funds and Equity Sector TMT hedge funds posted positive returns of 1.2% and 3.7%, respectively. Analysts attribute this closely to the strength of the semiconductor sector—the SMH semiconductor ETF rose 9.5% in June, while U.S. hyperscale cloud computing stocks fell 14.5% over the same period.

But signals changed in July. The daily correlation between Equity L/S funds and semiconductor stocks has noticeably declined. JPMorgan's high-frequency leverage proxy indicator also shows that leverage levels retreated in July—this indicator had risen to its highest level since 2017 in June.

Based on this, JPMorgan judges that Equity L/S hedge funds likely reduced their semiconductor exposure in July.

H2 Supply and Demand: Retail Capital as the Biggest Support

Deleveraging is a short-term headwind, but JPMorgan analysts also point out that over a longer cycle, the stock supply-demand structure remains positive, which will provide support once deleveraging pressures subside.

Analysts summarized the capital flow forecasts for various investor types:

Demand Side:

• Retail investors are the biggest support force. Year-to-date inflows are approximately $550 billion, with the full year potentially exceeding $1 trillion. An estimated ~$482 billion inflow is expected in the second half.
• Sovereign Wealth Funds/Central Banks: Expected to contribute ~$110 billion in stock demand for the full year, with about half occurring in H2.
• Equity Long/Short Hedge Funds (~$1.4 trillion AUM): Net bought ~$20 billion year-to-date, but analysts expect little room for further increases in H2.
• CTA Trend-Following Funds: Momentum signal z-score is around 1.0, with net buying expected to be near zero in H2.

Pressure Side:

• Pensions and Insurance Companies: Structurally reducing stock exposure. Expected net selling of ~$470 billion for the full year 2026, with about $235 billion in H2.
• Balanced Mutual Funds: Have net sold ~$210 billion in stocks year-to-date, concentrated mainly in June.

Overall, analysts estimate net stock demand of ~$475 billion for the full year 2026, with net supply of ~$200 billion (including three major AI-related IPOs), resulting in net demand of ~$275 billion, of which ~$197 billion is in H2.

The analysts specifically note that this positive supply-demand balance does not contradict the deleveraging pressure—"The deleveraging process may dominate the market in the coming months, causing significant price volatility, while the stock supply-demand balance acts more like a background, long-term force that will provide support once deleveraging fades."