Author: qinbafrank
How far has the compression-style deleveraging come?
As previously discussed, the essence of the recent market adjustment is the deleveraging of high valuation, high leverage, and high position growth sectors. The core issue is that the macroeconomic environment has not worsened enough to trigger a recession trade, but it has also not improved to allow the Federal Reserve to shift towards easing.
In the context of lacking a safety net of easing, the high leverage and crowded trades of high valuation growth sectors (especially high beta varieties like semiconductors) have been jointly triggered by long-end rates, oil price disturbances, and the risk-averse sentiment before the earnings season, forming a deleveraging pressure that can be termed as compression-style deleveraging.
1. What is compression-style deleveraging?
The recent rapid decline of the global semiconductor sector is not a traditional collapse of fundamentals, but a typical "compression-style deleveraging".
Its essence lies in:
When a sector is driven by attention during a bull market, boosted by narratives, derivatives, leverage tools, and crowded funds, once marginal conditions change slightly, the market can complete a full risk release that would normally take weeks or even months, within a very short period.
Price, narratives, options, leveraged ETFs, margin financing, and high position holdings all reverse in sync, forming a rapid collapse of trading structure.
Source of Speed: Synchronized Expression of Multi-layered Leveraged Narratives
The speed of this adjustment greatly exceeds historical cases, mainly because the market has upgraded from simply "buying stocks" to "buying multi-layered leveraged narratives". A semiconductor long position simultaneously exists in:
1) Spot stocks and high beta individual stocks
2) Single name options, OTM call options, LEAP long-term options
3) Leveraged ETFs (SOXL, Korean chip leveraged ETFs)
4) Thematic funds, CTA strategies, volatility control models
5) Margin purchase balances and trend-following funds
This results in when there is an increase, all expressions simultaneously increase delta; when there is a reversal, all expressions simultaneously decrease delta, forming an extreme symmetry of "consensus reinforcement" and "crowded stomp".
When everyone adds positions in the same direction, they will also reduce positions in the same direction. Liquidity seems abundant but is in fact extremely fragile. Once prices can no longer continue to rise, the delayed counter-evidence will erupt concentrically.
Leveraged ETFs are particularly amplifiers.
SOXL seeks a threefold daily performance of the semiconductor index. Its daily rebalancing mechanism amplifies returns in a unilateral trend, but in high volatility reversals can significantly magnify drawdowns through compounding path dependency. Once the underlying index experiences significant fluctuations, even if it eventually returns to the original point, the net value of a 3x ETF may incur severe losses. When a substantial amount of short-term and trend-following funds concentrates on such products, the ETFs themselves become amplifiers of sentiment and liquidity.
2. Therefore, this adjustment is not a macro main decline, but the macro environment has not provided any rescuing good news
1) Weak non-farm payrolls have eased the pressure of "immediate rate hikes", but the Federal Reserve's reaction function still keeps "rate cuts to save valuations" out of reach. For high-valuation growth stocks, this environment is the most awkward—growth has not deteriorated enough to require Federal intervention, and inflation has not improved enough to rapidly decline discount rates.
2) Geopolitical factors are not the main cause, but oil price rebounds and inflation expectations are also disturbances. Brent/WTI recently jumped above $70, having a limited impact; if it continues to break through $80-85 and drives up inflation expectations, forward inflation, or 2Y/10Y yields, it will truly become a dominant factor.
3) Dollar liquidity: Bank reserves do not support a systemic liquidity crisis
On July 1, the balance of reserves was $3.077 trillion, higher than the $2.954 trillion on June 24. This indicates that at least from a systemic liquidity perspective, the drop was not caused by a sudden tightening of dollar-based liquidity.
4) 10-year yields above 4.5% are not the main driving factor but a catalyst
At around 4.55% for 10-year yields, there is pressure on high-valuation growth stocks from three layers: valuation discount rate pressure,
capital expenditure financing cost pressure, and the nature of interest rate increases (more closely driven by oil prices and inflation expectations).
Thus, US10Y is not the root cause of this adjustment, but it is an igniter of the stampede. If it falls back below 4.45%, risk assets will noticeably ease; if it breaks through 4.65%-4.70%, even without new macro bad news, valuation repricing will continue.
Therefore, the core remains high leverage, squeezed positions, and overheated trading of high-valuation growth. Under this structure, the market does not need a full macro collapse; it only needs a sufficiently strong trigger—semiconductor volatility, oil price jumps, long-end rate rises, or risk-averse stances just before earnings—any one of these could lead to a collective adjustment of risk budgets. This decline shows characteristics of "many kills many".
The market has also shifted from "is there demand" to "can demand support the current scale of capital expenditures and valuation levels", during earnings season, one cannot only look at EPS exceeding expectations, but also must focus on cloud revenue growth rates, order/backlog situations, capital expenditure guidance, as well as free cash flow and profit margin guidance. Thus, the risk-averse factor before the earnings season is also present.
3. Key question: How far has deleveraging come?
In the final stage, look not at the percentage of declines, but at whether the structure has reset:
1) On the form level: After extreme volume in SOXL, no new lows are made, core varieties like semiconductors are no longer leading the declines, a structure that opens low and recovers volume, and does not reach new lows for 2-3 consecutive days. High beta storage stocks stop breaking down, and Korean core weights are no longer crushed by good news;
2) On the indicator level: The overcrowding of OTM calls and LEAPs decreases, call skew recedes, and the put/call ratio rises.
3) Negative news no longer triggers a new round of major declines, while good news can once again push stock prices up.
4) Signals from interest rates and oil prices: 10-year yields stop rising and fall back below 4.45%-4.50%, and oil prices do not continue to spike.
5) A key aspect recently is whether next week's CPI can smoothly pass, of course, the most critical is earnings, previously discussed essential points of earnings season.
Personal Perspective
Last night's market performance gave me some signals that deleveraging is nearing its end; I will discuss this in detail later.
This compression-style deleveraging warns us:
Real bottlenecks are overestimated and magnified by multi-layered leverage and crowded expressions, when good-news-down occurs, the market synchronously compresses price, narrative, and leverage in a very short time.
Semiconductors remain a long-term core asset, but only by understanding the structural essence of compression-style deleveraging can one maintain discipline in a high-speed reflexive market, rather than being swept along by sentiment and tools.
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