The Second Quarter Has Been One Giant Short Squeeze

It has been an odd time in capital markets: on one hand rising rates, a surging dollar, and a 4 year highs in oil have wreaked havoc on Emerging Markets, and may soon spill over to developed markets although so far US stocks have been resilient, if failing to break out of the recent range despite the small-cap Russell 2000 hitting new all time high. At the same time, a financial publication used several hundred words  to not so simply say that there was $8.8bn in equity inflows into US stocks even as the S&P had its biggest weekly drop in over a month; meanwhile the VIX has been grinding lower despite Italian populist forces forming a government in Europe's 3rd largest economy, with VIX net specs turning negative for the first time since the February VIXplosion as vol selling is all the rage again.

So what's really going on?

The answer is simple: the second quarter has been one giant short squeeze.

As has so often been the case, following the violent market moves in February and then again in late March, hedge funds reloaded on shorts and sector ETFs. According to Goldman's Ben Snider, YTD, stocks in all sectors but Consumer Staples have seen a rise in short interest as a share of float. Hedge fund net short positions have also increased in most sector ETFs, while Goldman's Very Important Short basket, containing S&P 500 stocks outside of the VIP list with the largest notional value of short interest, has underperformed the S&P 500 by 180 bp YTD (0.7% vs. 2.6%).

Then things changed in the last two months, or since the start of Q2, when as Goldman's prime desk reports funds aggressively covered the most crowded short positions. In fact, as the chart below shows, stocks with the highest short interest relative to float have outperformed their peers in most sectors. The outperformance has been particularly dramatic in the Energy sector, which experienced a large increase in hedge fund net positioning during 1Q and has been the best-performing equity sector thus far in 2Q.

And the punchline: since the start of 2Q, large-cap Energy stocks have returned 15%, small-cap Energy stocks have returned 24%, and the most heavily shorted Energy stocks have returned 30%. In short: the biggest outperformers this quarter were those "most hated" names that saw the biggest short squeeze, a strategy that has been a guaranteed generator of alpha since 2012 when we first recommended going long a basket of the most shorted names.

It's not just single stocks and ETFs that saw another short wipeout. As Goldman also observes, while hedge funds kept their net and gross exposures elevated, futures exposures have fallen sharply YTD. Leveraged fund US equity futures long and short positions have each declined, however as abnove, shorts have fallen materially more than longs.

Goldman concludes that "this is the first time since the start of 2009 that leveraged funds have had a substantial net long position in US equity futures." Or said otherwise, that there are now far fewer shorts left to squeeze and cushion the market during the next sharp move lower.

 

Comments

Honest Sam back to basics Mon, 05/21/2018 - 11:18 Permalink

What T F, is left to explain?

Truth exists and it is simple. CBs are the Solar lasers with unlimited power.

Central banks entered into a conspiracy with Satan in 1913. As long as the Treasury can issue paper, and the Treasuries in the CBs of the world buy them, the loop can be run like a perpetual motion machine.  The consequences foisted off until the earth is hit by an errant asteroid, is knocked off into the multiverses, or a volcano spews enough ash into the air to blot out the sun---which is engaged in its own radiation war against Earth, trying mightily to destroy us or even better, our electronic grid in one swell foop. 

It is the lies that require invention, and millions of words to rationalize the lies, give them gravitas, a faux authenticity, a phony raison d'etre that, if iterated often and for a long time, is accepted as truth. 

"Any man who requires of everything, can be certain of nothing, but perishing quickly."

 

 

 

In reply to by back to basics

tunetopper back to basics Mon, 05/21/2018 - 15:50 Permalink

Right ON!  A better story here would be the fact that due to the dismantling of the Volcker Rule, and the tax favored treatment of certain types of Investment Advisory pass-thrus, we're seeing an unprecedented revival of Hebrew Hedge Funds being created.... just today Izrael Englander (of Ivan Boesky fame) has raised $8B in new money to start an old style "80s" hedge fund, just TODAY.  Read the book by James Stewart Den of Thieves-  and see how John A Muhlheren securities &  Izzy Englander's "JAMIE" Securities used a technique called "Parking" to create faux capital.. and head trader of Millenium's Hedge Fund Michael Davidoff squealed like a pussy to the Feds.   Its all coming full- circle.  They're getting the BANDS back together.

In reply to by back to basics

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In reply to by sandraloopz0

Don Sunset Sat, 05/19/2018 - 17:54 Permalink

The Orange Joolius has sold out the financial conservatives.  It will be clear by 2020 to the dumbest of the dumb that we are on a deficit spending / tax cut path to insolvency.  Alarm bells will be screaming.

trader_pooh Sat, 05/19/2018 - 17:59 Permalink

I don't quite understand the rationale behind many companies' stock buyback program.

Doesn't it mean that there are fewer opportunities in their business sectors? 

heretical trader_pooh Sat, 05/19/2018 - 18:25 Permalink

Many of the execs are paid (or at least, receive bonuses) according to the share price of the company. Buying the company's own shares increases their value, since shares become scarcer. Also share dividends rise, because with less shares in public hands, more can be paid (it is split less ways). This also increases the value of the shares.

"Doesn't it mean that there are fewer opportunities in their business sectors?"

I think the core business is just regarded as a cash cow. They are all now in the same business sector, which is financialization.

In reply to by trader_pooh

Sudden Debt Sat, 05/19/2018 - 18:02 Permalink

If the 70's are an example and those who have a timehorizon of 25 years on investments, they'll see a 10% increase in value each year if they hold on.

Inflation is hitting the economy and the stockmarkets will follow suit.

But the runup from the 70's to the end of the 80's where pretty rough economicly. For example, interests for buying a home where at 15% and loans where non existend which made it pretty hard for the industry to finance projects.

 

MuffDiver69 Sat, 05/19/2018 - 18:12 Permalink

There are multiple signs of equity strength going on below the surface of the major indexes, which could be a signal that the recent uptrend in stocks is justified and could continue.

 

One positive signal looks at the ratio of rising stocks on the New York Stock Exchange to the number of falling ones over time.

Paul Schatz, the president of Heritage Capital, referred to this as “the one indicator that’s 90% accurate” for forecasting moves.

 

Currently, the NYSE’s advance/decline line is at an all-time high.

When the major stock market indices make new highs but the NYSE A/D Line does not, that’s where bulls should begin to worry,” he wrote, adding that “the exact opposite is happening,” which he said was “typically a good sign for further strength in stocks over the medium-term.”.

Keltner Channel Surf Mon, 05/21/2018 - 10:52 Permalink

We're at 3rd standard dev envelopes on intraday (60m,30,etc) charts in SPY, IWM & DIA (but not QQQ/COMP).  I've NEVER seen an open at that level continue through noon in 6 years of staring at this stuff, so there's no question a bunch of mean-reverting machines have just shorted the day's high, and if we blast through, we'll see 450-500 points hit really quick, as I imagine stops would be tight, positions medium to large.

However ... any betting man would say we'd head now for an attempt to breach day's lows before such reinforcements would be available.  I'd be shocked if it didn't happen, but it wouldn't be the first in the Trump market era ...