As we have repeatedly pointed out, the one surest way to generate profits in these manipulated, broken markets is to take advantage of the one legacy trade that makes zero sense in a world in which the global central banks are the ultimate providers of downside risk protection: i.e., going long the most shorted names. We did just this most recently past Friday [9], when we listed the latest hedge fund long hotel, as well as the names most shorted by the "sophisticated" investors, saying "anyone going long these names is virtually assured to outperform the market over the next year." One day later and this "strategy" is already generating outsized alpha, with the most shorted names solidly outperforming the market.
[10]
And as the case may, this latest bout of "most shorted" outperformance is set to continue for one main reason. As the CFTC reported last friday, institutional investors using Standard & Poor’s 500 Index futures turned bearish this month for the first time since September 2012.
Incidentally, September 2012 is precisely when we first said [11]that the one trade guaranteed to generate outsized returns is to go long the most shorted names. This is what happened next:
[12]
As Bloomberg reports [13]: "Hedge funds and other large speculators have been net short for the last two weeks, wagering that the S&P 500 (SPX) will decrease in value, according to data compiled by Bloomberg and the U.S. Commodity Futures Trading Commission."
This is how the net HF exposure looks like:
[14]
Bloomberg adds:
“Everyone made a ton of money last year being long and they may be hedging their portfolios in the S&P 500 futures market,” Eric Green, director of research and fund manager at Penn Capital Management, said by phone on Feb. 21. The Philadelphia-based firm oversees $7.5 billion. “The bad economic data and the emerging-market news that broke in January have all contributed to more negative sentiment.”
Negative sentiment which, however, this time is being "explained away" with the weather. Because remember: it is never the economy's fault, and whenever we get bad data, it is the snow, or the rain, or the sun's fault. When we get good data, it is always the economic recovery, never the trillions in liquidity injected by the Fed.
Sure enough:
Investors have dismissed worse-than-forecast U.S. economic data over the past two weeks, speculating that harsh winter weather explains the weakness in reports such as housing and hiring. The Bloomberg ECO U.S. Surprise Index, which measures how much recent data has beaten or missed economists’ estimates, fell to minus 0.429 last week, the lowest since August 2011.
One would have to ignore the fact that "harsh winter weather" apparently impacted housing data in California, or that the recently reported Dallas Fed, where snow was just a little scarce this winter, also scapegoated the weather. Or that the "recovery" momentum of the entire world's macro data has reverted to multi-year lows - apparently it snowed everywhere, despite what we noted last night, namely that it was the fourth warmest January on record [15].
[16]
Of course, we did preface this post with "most manipulated, broken markets", so little surprise there.
As for the real reason why markets continue to surge higher:
Bearish bets against the S&P 500 shrank to 12,085 contracts in the week ended Feb. 21. Based on the price of the futures contract, that amounted to a notional value of about $5.6 billion in bets against the index.
Investors were net long S&P 500 futures by 30,000 contracts on Jan. 10, for a swing of about 40,000 contracts in the past five weeks. That’s the biggest bearish move since August 2011, when hedge funds went from being net short 4,400 contracts to net short 107,913 contracts, according to CFTC data that started in 1997. That move preceded a 9.8 percent retreat in the S&P 500 as investors sold stocks amid Europe’s government debt crisis.
In other words, every time even a modest threat of a downside correction reappears, momentum ignition across key FX carry pairs sends the Spoos and other equity indices higher triggering upside stops, which in turn forces even more hedge funds to cover short positions, once again sending the S&P too all time highs. And so on. Until the volume in the market is so low one block of E-mini futures sends the whole thing limit up, and everyone can just sit back and laugh.