With just one month left in the quarter, most hedge funds continue to underperform the market, not to mention that the vast majority continues to be under their high water mark (most notably Citadel). And with fickle LPs, unbound by lock ups courtesy of the 2008 crash, knowing all too well they can now move their money with the facility of a HFT frontrunner churning AMZN one thousand times a second, threatening redemptions unless something changes in the last month of the quarter, hedge funds are, for lack of a better word, panicking. Yet as we have long been demonstrating, the vicious loop of high correlations and mutual fund withdrawals means that alpha generation is gone the way of the dodo. Which means that HFs will now seek to actively lever up into the market to chase the beta wave over September like never before. This is indeed confirmed by TrimTabs latest Hedge Fund Flow Report, which finds that the percentage of HF managers expecting to raise their leverage exiting August is 21.2%, the highest in 4 months, and possibly all of 2010, and triple the 7.7% responding affirmatively in May. And as riding a leveraged beta wave is nothing but a coin toss on the market with dire consequences if wrong, look for market volatility in September to hit multi-month highs, especially if macro economic conditions continue to deteriorate and investors are forced to buy against the grain.
The chart below shows the trend of increasing desperation in the hedge fund community:
Here is TrimTabs explanation:
Hedge fund managers are also more inclined to lever up than they were last month. About 21% expect to increase leverage in the next month, sharply higher than 14% in July. Only 11% of managers aim to decrease leverage in the coming weeks, the smallest share since the start of our survey in May. We suspect managers are feeling bolder because recent outflows proved relatively mild. We estimate that hedge funds redeemed only $2.7 billion in June and $3.0 billion in July. Managers were much more reluctant to increase leverage when credit fears in Europe triggered concern about another liquidity crisis.
Additionally, TrimTabs has found that bearish sentiment on stocks in August is the highest it has been since May. Of course, the simplistic contrarian view is that with so many bears out there, the market is poised to rebound.
Hedge fund managers have turned markedly more bearish on equities. About 47% of the 104 managers we surveyed in the past week are bearish on the S&P 500, up sharply from 33% in July. Bullish sentiment decreased to 17% from 34%. The August bearish reading of 47% is the highest since May’s reading of 52%, which bodes ill for equities.
Yet despite the increasing alleged equity bearishness, there was no corresponding increase in NYSE short bets, and in fact, July saw a decline, making one wonder just how truthful the sampled respondents were in their answers:
Bearish sentiment did not prompt a spike in short bets. Indeed, NYSE Short Interest decreased 1.7% in July to land 5.4% south of the June peak. We suspect Short Interest declined because the strength of the July rally took managers by surprise and forced them to cover underwater positions. Our research shows that changes in Short Interest are historically a leading contrary indicator, so we believe the recent decrease in short bets favors lower stock prices.
So what does all this mean? Absolutely nothing. The days when hedge funds (or equity mutual funds) mattered are long gone: the only thing that is relevant these days is on what side of the bed does Bernanke wake up, and what subliminal messages about the imminent date of QE does his blinking pattern telegraph to the primary dealers. Everything else is noise. Yet the increasing leverage is a fact (we have confirmed this via independent conversations with Prime Brokers) and more than anything, it means that just like some hedge funds will make off like bandits in the next 28 days, others will most certainly blow up. Perhaps the administration can just advise where the S&P will close to within a penny of the final price on September 30, so we can proceed straight to the heckling festivities.