U.S. Stocks Still Have Room for Deleveraging: JPMorgan Says Three Months Needed to Return to Pre-April Levels

Original Author: Long Yue

Original Source: Wall Street Sights

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

According to a tip from Zhui Feng Trading Desk, the latest report released by JPMorgan's Global Market Strategy team on July 15 indicates that the investor deleveraging process initiated in the U.S. in June is still ongoing. There is further room for deleveraging in three areas: leveraged stock ETFs, the options market, and margin accounts. This will continue to suppress stock market performance in the coming months.

They estimate that it will take approximately three more months of range-bound trading to bring the ratio of leveraged stock ETF size back to the level seen before April relative to the market capitalization of the underlying assets.

Leveraged ETFs: Self-Correcting Mechanism Activated, but a Long Road Ahead

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

The bank explains the logic: Suppose the underlying index falls 10% one day and rebounds 11.1% back to its original position the next day. A 3x leveraged 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, range-bound trading itself erodes the size of leveraged ETFs. This is a built-in "self-correcting" mechanism.

The data confirms this. Analyst data shows that since the peak, the size of leveraged semiconductor stock ETFs has shrunk by 34%, while all leveraged stock ETFs have shrunk by 13%.

But the problem is that the decline in the ratio relative to the market capitalization of the underlying stocks is much smaller.

JPMorgan analysts point out that the ratio of leveraged semiconductor stock ETF size to its underlying market cap is three times the average for all stock ETFs. This explains why semiconductor stocks have much higher volatility than the broader market. More concerning is that even for the overall leveraged stock index ETF, its ratio is high relative to its own history, indicating this is not just a sector-specific issue but a systematic risk across the entire market.

The analysts judge: "It will take approximately three more months of range-bound trading for the ratio of leveraged stock ETF size to underlying market cap to return to levels seen before April."

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

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

In the options market, JPMorgan analysts track a retail bullish call buying indicator (based on OCC data, counting customers holding fewer than 10 contracts). This indicator hit a peak of nearly 14 million contracts on June 5, matching the historical highs of October 2025 and November 2021.

Historical patterns show that each time this indicator peaks, tech stocks undergo several months of adjustment, with the bottom often corresponding to the indicator falling to a low of 2 million to 4 million contracts. This indicator has clearly fallen from its peak, but analysts believe that if it eventually drops to the 'capitulation' level of 2 million to 4 million contracts, tech stocks will still face sustained pressure.

The situation is even more severe with margin accounts. Analysts use the NYSE Net Debit Balance as a proxy indicator for U.S. individual investor leverage. The data shows current levels are at historical extremes, comparable to the peaks of late 2021 and mid-2018—and after those two peaks, the stock market experienced months of adjustment.

Analysts note that margin accounts have shown some signs of recent decline, but "a significant amount of deleveraging is still needed before they cease to be a major drag on the stock market."

In contrast, leverage at risk parity funds has largely returned to normal and is no longer a major source of market headwinds.

Hedge Funds: Semiconductor Exposure May Have Quietly Contracted

At the hedge fund level, the bank's data reveals an interesting shift.

In June, despite the decline in the S&P 500 and Nasdaq indices, Equity Long/Short (L/S) hedge funds and Technology sector (TMT) hedge funds posted positive returns of 1.2% and 3.7%, respectively. Analysts attribute this to the strong performance of the semiconductor sector – the SMH semiconductor ETF rose 9.5% in June, while U.S. hyperscale cloud stocks fell 14.5% over the same period.

However, the signal changed in July. The daily correlation between equity L/S funds and semiconductor stocks has notably decreased. The analysts' high-frequency leverage proxy indicator also shows a decline in leverage levels in July – after the indicator had risen to its highest level since 2017 in June.

Based on this, JPMorgan judges that equity long/short hedge funds may have reduced their semiconductor exposure in July.

Supply and Demand in H2: Retail Capital is the Biggest Support

Deleveraging is a short-term headwind, but the bank's analysts also point out that from a longer-term perspective, the supply-demand structure for stocks remains positive, which will provide support once the deleveraging pressure subsides.

Analysts summarized the capital flow forecasts for various types of investors:

Demand Side:

• Retail Investors are the biggest source of support. Year-to-date inflows have reached approximately $550 billion, with the full-year figure expected to exceed $1 trillion. An estimated $482 billion is projected to flow in during the second half of the year.
• Sovereign Wealth Funds / Central Banks: Expected to contribute roughly $110 billion in equity demand for the full year, with about half coming in the second half.
• Equity Long/Short Hedge Funds (managing approximately $1.4 trillion): Net purchases year-to-date are about $20 billion, but analysts expect little room for further accumulation in the second half.
• CTA Trend-Following Funds: The momentum signal z-score is around 1.0, and net purchases are expected to be near zero in the second half.

Pressure Side:

• Pension Funds and Insurance Companies: Structurally reducing equity exposure, with an estimated net selling of approximately $470 billion for the full year 2026, and about $235 billion in the second half.
• Balanced Mutual Funds: Have net sold approximately $210 billion in stocks year-to-date, mainly concentrated in June.

In summary, analysts estimate total net equity demand for 2026 at roughly $475 billion, with net supply of about $200 billion (including three major AI-related IPOs), resulting in net demand of approximately $275 billion, of which about $197 billion is in the second half.

Analysts specifically note that this positive supply-demand balance is not contradictory to the deleveraging pressure – "The deleveraging process may dominate the market over the coming months, causing significant price volatility. The stock supply-demand balance acts more like a background, long-term force that will provide support once the deleveraging subsides."