Market Strength Persists as Citadel Sees Fundamentals Returning

The Retail Unwind

Leveraged ETFs magnify daily returns on a stock or index and have become a favorite vehicle for speculative retail trades.

Technology shares, a major driver of this year's record stretch, tumbled last month as investors worried that the artificial-intelligence trade had become overheated. In July, the Nasdaq 100 fell by the largest margin in more than a year, and an index tracking chipmakers suffered its worst month since 2008.

At the same time, funding costs for equity holdings have declined. That suggests Wall Street's trading desks face less strain and that investor appetite for borrowed money has dropped. The market had become increasingly reliant on a small cluster of AI-related winners and on retail money flowing into leveraged products. The July reversal in chipmakers and mega-cap technology names broke that dependence, and the drop in funding costs signals less borrowed money underpinning positions.

What It Means for Investors

The recent unwind has drained the type of crowded positioning that made the market vulnerable to sudden swings. Lower financing costs and reduced leverage also point to a less fragile system, even after a sharp reversal in sentiment for AI-related stocks.

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Earlier this year, retail traders were a significant source of buying power, feeding money into leveraged products and momentum trades. The sharp reversal in that participation has reduced the potential for forced selling. With debt-financed positions smaller, the probability of cascading unwinds has also decreased.

Scott Rubner, the market maker's equity strategist, told clients in a note that the market was moving past the recent bout of positioning-driven swings.

"Markets are transitioning from a flow-driven environment back to one increasingly dictated by earnings, corporate demand, and the macroeconomic backdrop," Rubner wrote.

Rubner added that speculative excess has mostly cleared, and with companies clearing already high bars, the latest earnings season should support U.S. equities.

"Earnings continue to surprise to the upside, valuations have become more attractive, and corporate buyback demand is set to accelerate as earnings blackout windows expire," he noted.

"For the first time in several months, we believe investors can spend less time focused on positioning and more time focused on fundamentals," Rubner added.

Looking Ahead

Corporate stock repurchases tend to slow during earnings blackout periods, when executives and firms avoid significant share transactions while quarterly results are being prepared. With the latest reporting wave now largely complete, those restrictions are lifting. Citadel Securities expects buyback demand to accelerate as a result, which should give the market a steady source of buying tied to corporate cash flow rather than speculative positioning.

With reporting season in the rearview for many large companies, buyback demand is expected to pick back up. Combine that with lower leverage costs and attractive valuations, and Citadel Securities sees a market where fundamentals, not flows, have the upper hand.

This shift does not mean stocks will move in a straight line. But it does suggest that the correction triggered by overextended AI trades and retail deleveraging may have laid the groundwork for the next leg of the bull market.

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