Wall Street strategists are eager to raise their target for the S&P 500 index, but hedge funds are becoming increasingly cautious due to the Fed's unwillingness to lower interest rates, weak economic data, and narrow stock market breadth.

A report from Goldman Sachs' bulk brokerage division shows that hedge funds' long and short net leverage (measuring their overall exposure to the market) has experienced the largest decline since March 2022. The Goldman Sachs team wrote that this move indicates that so-called smart money is becoming more cautious.

These funds net sold U.S. stocks last week, mainly macro products such as index funds and ETFs. However, hedge funds became net buyers of individual stocks for the first time in six weeks, which may indicate that investment managers are becoming more selective.

The Goldman Sachs team wrote, “We believe the pricing of U.S. economic growth is optimistic and believe U.S. consumption has reason to pause. Our greatest concern is the risk of a downturn in trade and the condition of low-end consumers.”

After rising 14% in the first half of 2024, the S&P 500 index is approaching its all-time high of over 5400 points. Wall Street strategists are eager to keep up, raising their year-end target for the index, with the latest being Julian Emanuel of Evercore ISI, who raised his target to 6000 points last Sunday, the highest among the major stock strategists tracked by Bloomberg. Last Friday, Goldman Sachs' David Kostin raised his target from 5200 points predicted four months ago to 5600 points.

However, hedge funds seem skeptical of further gains. The Fed has said it expects fewer interest rate cuts in 2024 than investors had anticipated due to stubborn inflation, and economic growth remains uncertain, with geopolitical risks seemingly ever-present. Meanwhile, market breadth remains very narrow, with the rise being driven mainly by large technology stocks, while economically sensitive cyclical stocks continue to face pressure. This divergence is evident in both the conventional market-cap-weighted version of the S&P 500 and its equal-weighted counterpart.

Although the market-cap-weighted S&P 500 is nearing overbought territory, the equal-weighted S&P 500 is not overbought, with this year's gain of only 3.4%, far below the former and well below the total gain of 35% for the 'Bloomberg seven big tech giants'.

“Narrow breadth increases market fragility,” said Mark Connors, global macro strategy head of Onramp Bitcoin. “This is why hedge fund leverage is down and shifting from macro indices to individual stocks.”