These Are The Year-End Pain Trades

With just over a month left in the trading year, and the S&P 500 on pace to experience its best week of the year, morbidly enough in the aftermath of the Paris bombings, hedge funds, traders, banks and everyone else are once again commiting the cardinal sin of investing and the reason why so many "marquee" hedge funds blew up together over the summer: herding, and rushing into the handful of trades that have worked recently, which work until the blow up spectacularly.

But then again, with year-end bonuses on the table, few will dare to move against the herd, and while another eventual hedge fund hotel implosion is again assured, for now the clustering is imminent.

So what are the consensus trades as we approach the year end? They also happen to be the year-end "pain trades" because in a year full of flash crashes, close calls, dramatic reversals and international risk flaring, the Fed's ability to maintain the illusion of the rigged market is highly suspect, and if any of these "groupthink" positions blows up, that's precisely what will follow. Pain.

Here they are courtesy of Bank of America's Michael Hartnett.

  • US dollar sell-off: Nov’15 Global FMS shows “long dollar” most crowded trade; investors are unambiguously OW strong-$ plays (consumer, banks, Eurozone, Japan), UW weak-$ plays (EM, resources, commodities); positioning based on expectations of Fed hike, ECB cut, China deval; expect big profit-taking starting early Dec post-payroll.
  • EM rally: China deval complicates rally but humiliated EM ripe for bounce as Fed hike expectations peak; EM debt fund outflows 23 out of past 26 weeks; EM equity fund outflows 16 out of past 19 weeks; YTD $86bn outflows from EM funds = worst year of redemptions since 2008 (Chart 2).

  • Positioning less "bearish": BofAML B&B Index on upswing (@ 2.5 – Chart 1), retraced >60% of May-Aug collapse; should Fed hike coincide with weaker dollar = risk has potential to rally further; note risk rally is "narrow" and vulnerable to quick profit-taking in event-rich December: deteriorating RSP/SPY ratio (market breadth – Chart 3), deteriorating HYG/LQD ratio (risk appetite – Chart 4), US HY distress ratio (spreads >1000bps) on the rise.