Hedgies Coming Back In

Its not been easy for short sellers in 2023, starting off with the big rally in January, followed by the almost nonstop rally post SIVB from SPX 3850 to 4200 over the past 2 months.  Its been even worse for those who have bought puts, because not only has the market grinded higher, volatility has dropped like a rock, absolutely killing put holders.  Its been a meat grinder for those skeptical about the economy and the stock market.  For the bears who still have dry powder, this provides an opportunity to take advantage of the market's resilience.  

“Risk managers at big institutional firms are saying, ‘Look, the markets are going up, and you can’t sit around and do nothing, you have to participate,’"

Recent hedge fund positioning data coming out of Goldman, Morgan Stanley, and Deutsche Bank confirm that net equity exposure has been going up rapidly in the past 2 weeks, near a one year high, but at neutral levels going back to the past 10 years.  The hedgies could marginally increase their nets, but looking at the macro landscape with rates above 5%, its hard to imagine them getting aggressively long here.   Systematic equity exposure is back towards early 2022 levels, and is above the long term average.  Discretionary exposure is still below average, but has risen in the past 2 weeks.  If discretionary exposure can get closer towards neutral like systematics, that would be the no-brainer setup.  We're not quite there yet. 

With overall hedge fund exposures close to neutral levels, the scary short covering portion of this rally is over.  Now, it will require either strong inflows into equities or a chase for performance, ignoring the weakening macro conditions.  That is a higher bar for a continued rally than what we had earlier in the year.  With very positive skew and lower VIX, put spreads haven’t been this cheap since 2021.  A long term short position in SPX either outright short or via put spreads is at attractive levels.  

The love for tech stocks is getting excessive, especially the AI related stocks.  We have the famous investors pumping it now, after a huge move higher.  Whenever Steve Cohen, Stan Druckenmiller, and Paul Tudor Jones are touting something after a big move, run away.   They aren’t in the charity business, they are looking for exit liquidity.  The chart for NVDA looks ridiculous.  AAPL is trading like its totally recession-proof, and goes higher even as its revenues and earnings are stagnant.  These are the moves that make you shake your head.  Moves that make long/short hedge funds trading on fundamentals throw in the towel.  

 

Its been painful for those holding bonds as well.  Especially long bonds.  We are almost back to 4% on the 30 year, as you get banks reducing their duration to belatedly protect against interest rate risk.  But that horse is already out of the barn.  Those that hedge too aggressively here could be in a world of hurt if the economy enters a deep recession and their credit loan books get crushed while not having enough duration to soften the blow.  Its a mess out there for the banks, as this rise in long bond yields is not doing them any favors, amidst a steady outflow of deposits seeking higher yield.  

On to the news of the day.  Debt ceiling deal looked promising on Thursday, and then suddenly the two sides were far apart on Friday, and now back to constructive on Monday.  Wax on, wax off.  The people who were going to hedge for a potential debt ceiling debacle already have either hedged or reduced their positions.  So don't expect any last minute snags to plunge the stock market.  The only thing that will cause a debt ceiling selloff now is if there is an actual default, which would happen in June, if it did.  I wouldn't make that bet.  

Counterintuitively, the debt ceiling debate has been a positive for stocks by taking the focus off a weakening bond market (especially long bond yields), and the ongoing regional bank issues which have not gone away.  Those are actual real issues that can cause a real crisis, unlike the debt ceiling, so being able to worry about an artificial crisis instead is a relief if you are a stock market bull. 

I've kept my shorts in individual stocks, along with long positions in short to intermediate term bonds.  Still not ready to short the indexes, but it is getting more tempting.  Probably need to get the debt ceiling deal out of the way so that the chicken littles finally jump into equities, which could be the exquisite moment to put on index shorts/puts.  Not a big fan of shorting the index during a period of uncertainty, especially when its over a fake crisis.  Probably should have reduced some individual stock shorts when people first started talking about the debt ceiling issue in early May.  Could have, should have.  Can't turn back the clock.  At these levels, I'll just hang on.  Probably very little downside for this market until the debt ceiling deal is done, so looking at a market that won't go down much until early June.  Should be boring until then.