Russell 3000

The 'most shorted' names in the Russell 3000 are up a remarkable 1.4% today compared to 0.45% in the index itself. The short-squeeze off the NFP gap-down lows is impressive indeed. From the open last Friday, the 'most short' names are up 6.6% against the index up only 3.5% as the dash for trash continues in the face of increasingly dismal data. The last 2 times that the 'most short' index was this squeezed relative to the index was late-December (before the equity dip) and mid-Fed (before the equity dip). Just as we warned here and here, the inexorable flow of easy money means the dash-for-trash (as remarkably ridiculous as it seems - though as now know nothing is allowed to fail ever again) has been the winning trade; though as we note below, there is a limit to the 'squeezability' and we appear to be there in the short term.

The 'down-up' streak is over, long live the next streak. Precious metals had a big day with Silver and Gold surging 1-2% (among the biggest moves in 7 months); Treasuries pushed higher in yield from the open but faded rapidly into the close to end unchanged ay 1.75%; Commodities in general were bid on the back (supposedly) of China's lower inflation print; IG credit was bid while HY credit (spreads not the HYG ETF) rolled over into the close. What was most evident was the total and utter failure of the 3:30pm Ramp - it seems our discussion of the farce last night brought a world of front-runners to the game and ruined the Algos day as instead rallying S&P 500 futures dropped 4 points in the last 30 minutes - this is the biggest 3:30-to-4:00 loss in six week (and 3rd biggest of year). The world was celebrating another new all-time high in the Dow and the S&P gave back half its gains to close +4 points; but the Dow Transports closed -0.3%, and the Russell 2000 (for so long Bernanke's policy tool) ended -0.23%.

In the theory of rational expectations, human predictions are not systematically wrong. This means that in a rational expectations model, people’s subjective beliefs about the probability of future events are equal to the actual probabilities of those future events. Now, we think that rational expectations is one of the worst ideas in economic theory. It’s based on a germ of a good idea - that self-fulfilling prophesies are possible. Mainstream economic models often assume rational expectations, however. And if rational expectations holds, we could be in for a rough ride in the near future. Because an awful lot of Americans believe that a new financial crisis is coming soon - 75 percent of respondents said that it’s either very or somewhat likely that the country could have another financial crisis in the near future.

When it comes to popular finance myths, cash hoarding by corporates may be one of the most perpetuated. It's not that the data is wrong; US companies are holding more cash on their balance sheets than at any time in the past, as a report by Moody's this week notes. What's misguided is the narrative, in Citi's view, in particular among equity investors. What they most take issue with is the implication that corporates have lots of cash to return to shareholders. Indeed, there's plenty of data to the contrary that challenges the prevailing notion that corporates are the picture of good health.

If it's a day of the week ending in 'y' then sure enough the Dow is green - 10 days in a row - best run since Nov 1996. The cash S&P's all-time high remains a day or two away at 1576.1 but today's late-day ubiquitous idiocy (first via VIX and then via HYG) took it within a point of the all-time closing high of 1565.15. Volume - take a guess! Trannies outperformed as 4 different stocks were short-squeezed this time to drive half the index's performance (CNW, R, KSU, and UNP). VIX daggered lower to new cycle lows ending at 11.05% at its lows. Away from that tom-foolery, stocks were 'supported' by USD weakness as GBP ramped higher on pre-budget excitement and EUR just because why not; Treasury yields ended the day near the lows of the week - entirely in keeping with the highs of the week in stocks... USD weakness helped WTI rise on the day - now best performer on the week among the commodities with Silver lagging on the week (while gold limps higher). Just another day in dystopia... ahead of the CCAR Part 2.

Following up on our recent discussion of the worst-is-first rally that we have all been witness to in the last few weeks, we thought it noteworthy that the 'most-shorted' names in the Russell 3000 and the index itself have now recoupled from their epic divergence post-QE3. We have seen five large short squeezes 'engineered' since the lows in March 2009 - and given Citi and BofA's 17% gains in December alone, we suspect (and have heard from more than a few funds) that year-end is bringing some forced buy-ins as SecLend desks become a little more activist.

The broadest US equity indices began to fall following the 2nd Presidential Debate in mid-October, and stabilized after the 3rd Debate. Weakness was well balanced with the 'most-shorted' names staying in sync with the indices (in a more systemic risk-off manner). Hurricane Sandy appears to the beginning of traders pressing the most-shorted names (we would suspect this was beta chasing on expectations of weakness) and then once the election results were known the most-shorted names really outperformed (i.e. fell considerably more than the index). As the chart below shows, just as the Washington 'cone of silence' began, the Russell 3000 had fallen 6% in November (and 8% from the 2nd debate), while the Russell 3000's Most-Shorted Index had dropped almost 10% for the month (and 12% from the debate) for a massive 400bps outperformance. The following two weeks led to today where the most-shorted index has been squeezed 9.25% higher to catch up to the broad Russell 300's performance for the month. As the month closes, the index and its most-shorted names are perfectly in sync and unchanged with one another - thus reducing dramatically the fast-money ammunition for further squeeze potential.

Confused at why the stock market has risen phoenix-like this week amid no-news on the fiscal cliff, a lack of closure on Greece and EU budgets, and a further collapse in Japan's trade balance? Wonder no longer; for the explanation is simple - a massive and dramatic short-squeeze has created a 200bps outperformance this week among the most-shorted Russell 3000 names. Impressive indeed; sustainable? One wonders if an "expert network" was used by various known and unknown CT-based hedge funds for "advice" to ramp stops in the highest beta, most shorted stocks in a market in which volume would be so abysmal any entity which already controls 10% of NYSE volume could do with the market as it saw fit?

Want to get into the head of a hedge fund manager, and see how they view the market: why just buy Apple of course, however good luck explaining to your LPs why you deserve 2 and 20 for "active asset management" aka just following the herd into the biggest hedge fund hotel in history (for at least 216 hedge funds it may be a tough sell). So for everyone else, Goldman's David Kostin (who still has a 1250 year end S&P target - the definitive indicator to sell everything will be when he too gives up) has compiled the data in all the just released 13Fs and has summarized the results as follows...

The so-called January-Effect is almost at an end and if the market closes near these levels, the S&P 500 will have managed a 4.4% gain or its 20th best January since 1928 (84 years) and best since 1997. The outperformance of banks and sovereigns (LTRO) and the worst-of-the-worst quality names (most-shorted Russell 3000 stocks +9% YTD vs Russell 3000 +5.2%), as Morgan Stanley noted recently, is not entirely surprising since the January effect is considerably larger in mid-cap and junk quality names than any other size or quality cohorts. We have pointed to the seasonal positives in high-yield credit and volatility and along with the obvious short squeeze in S&P futures (which has seen net spec shorts come back to balance recently), we, like MS, are concerned that the tailwinds of exuberance that virtuously reflect from seemingly pivotal securities (such as short-dated BTPs now or Greek Cash-CDS basis previously) very quickly revert to a sense of reality (earnings and outlook changes) and perhaps the slowing rally and rising volatility of the last few days is the start of that turbulence.

We discussed the bullish themes (and Nomura's skepticism) earlier today but as the S&P 500 cracks 1300 once again and banks (GS cost-cutting sustainability?) and builders (NAHB Index? context please) are off to the races once again, we thought it might be appropriate to see just how well the worst of the worst has outperformed the market. Using our standby GS index that tracks the most shorted names in the broad market, we see that year-to-date, the most-shorted names are up 5.8% against the Russell 3000 which is only up 4%. Furthermore, since late yesterday, the most-shorted names have doubled the market's performance (+2.1% vs +1% from 1430ET yesterday).

Yesterday we highlighted the top 50 stocks that comprise the hedge fund "darling" universe. And while it is good to know which stocks will get the chop first the next time there is a major margin call induced liquidation scare, as David Kostin points out in a follow-up piece there is a much more nuanced read through for Hedge Fund data. "We estimate hedge funds own roughly 3% of the US equity market. Turnover of all hedge fund positions averaged 34% during 3Q 2011 (nearly 140% annualized). The tilt of hedge fund holdings towards large-cap stocks has been increasing for almost 10 years. The typical hedge fund operates 36% net long, down from 2Q 2011. Combining long and short position data, hedge funds have the greatest net portfolio exposure to Consumer Discretionary (23%), Information Technology (20%), and Energy (14%)." he then proceeds to list the 10 conclusions that can be derived using the most recent public 13F data (which is understandable quite stale already in our day and age of sub-24 hour investment horizons). Yet the bulk of conclusions are mostly fluff save for the following: " The average hedge fund returned -2% YTD in 2011 through November 11th compared with +2% for the S&P 500", "Hedge fund returns are highly dependent on the performance of a few key stocks" and "The typical hedge fund operates 36% net long ($394 billion net/$822 billion long), versus 46% in 2Q 2011." So just why do people still pay 2 and 20 to chase popular, concentrated stock positions while underperforming the broader market again?

Still unclear on what drove the policy vehicle known as the stock market straight up, which for some reason speculators still participate in despite relentless warnings that it is broken, manipulated, etc, for nine consecutive days, following the release of the FT rumor of a bank recapitalization on October 4, since refuted? Simple: look at the chart below. The Green is the Russell 3000, while the Red is the Goldman "highest short interest index." Beginning with September 4, and continuing through today, every time the market appeared poised to drop, market makers would mysteriously squeeze shorts, with the Red line consistently leading the overall market (Green). Said otherwise: shorts panic -> weak hands cover -> market follows. Naturally, for this to work, volume has to be well below average, which was indeed the case - the volume has been abysmally low for the duration of the entire melt up which means the second there are no incremental weak hands to short, and the movement flips, most likely on the fully priced in deus ex bail out of Europe which will not happen next week or ever, massive volume will return, and the market will do what it always does in such situations: soar inversely. Until then, and as always, it is best to play in other, less manipulated venues - buy some CDS, arbitrage some shiny rocks, blow some money on Blackjack, just stay away from the frontrunning algos whose only purpose is to sniff out weak shorts and sell stops. There is no market: we would say it is a casino, if only it was even 10% as fun.

We have highlighted this before but given the incessant rumblings that everything is fixed and that nationalizations, recaps, and EFSF votes are 'positive', we thought a reflection on what is really going on would be useful. The mother of all short squeezes as we mentioned recently continues - catalyzed by the since refuted FT Rumor of a pan-European bank recap 'plan'. The fact that Short Interest is at its highest since the "generational lows" only helps.

Credit Suisse and Goldman Sachs have two indices that track the most shorted (highest short interest) stocks in the S&P500 and Russell 3000 respectively. This afternoon's action shows a considerable outperformance by the Russell 3000 most-short index over the Russell 3000 while the S&P 500 most-short index has stayed relatively well-behaved relative to the S&P 500. It seems smaller cap shorts have had the stuff squeezed out of them today.