When commenting on yesterday's somewhat puzzling, low-volume levitation, we noted that it was not so much a broad market rally, which it certainly was if rather muted, but the biggest short squeeze since at least the Trump election victory 2 years ago.
To be sure, there was also a massive positioning (and career-risk) imbalance because as Nomura's Charlie McElligott writes, as funds of all types were practically forced to “take-up nets” and “buy” the year-end rally thesis - after "loving" the still "growth-y" NAHB sentiment and IP data - they boosted too fundamentally following the critical earnings beats from bellwethers LRCX, NFLX and ASML over the past 24 hours. This echoes a point McElligott has vocally made in recent months, namely that "if you think SPX rallies into year-end, you then too MUST have a positive view on Tech / Growth."
Additionally, after last week's rout which slammed vol-targeting funds such as risk parity, CTAs and variable annuities, many were still caught in a deleveraging phase as they moved to realign their risk exposure to the next level of the VIX, while as Kolanovic explained last week, there was also residual pressure from dealers who were still hedging gamma exposure in the options market.
Commenting on yesterday's sharp reversal, McEllgiott writes in his latest daily note that while the move in stocks was impacted by said gamma options-hedging, that wasn't the primary driver as they have simply gotten “too expensive” (there was no “upside grab” yesterday) but instead "the move then was driven by "active hedging" in futures and ETFs to "manage funds’ exposure-levels."
So between dealer gamma hedging, a reversal in vol-targeting selling, and a general scramble for P&L by the badly underperforming active investor community, the Nomura X-asset strategist writes that the entire spectrum of the trading universe came for U.S. stocks yesterday:
- Yes, options dealers are still short “enough” gamma to impact market flow, so there was absolutely some delta hedging into the close—thus the “rip” into the close / large +++ MOC
- We also did trigger incremental systematic CTA BUYING yesterday, with S&P taken back UP to “+49% long” from “+43% long,” meaning +$6.8B of Spooz buying; FWIW Russell also increased from “neutral” to “+43% long” as well
- Who else was buying? Everybody who NEEDED TO TAKE UP NET EQUITIES EXPOSURES from last week’s lowest levels of the year: macros (still with “beta to Equities” off a very low base) to long-short (Street PB data showing just +48% net exposure last week) to mutual funds (yes, they can toggle their “cash” and “beta”)
And yet, despite yesterday's furious, 500+ point Dow rally, there was a moment of brutal irony about the rally for the smart money, because as noted above, while long soared higher, shorted exploded even more. This means that from a performance-perspective, despite the whopping-rally (+2.2% SPX, +2/9% NDX, +2.8% RTY and +2.2% RIY), Hedge Funds only saw a very modest lift as McElligott's HF L/S model was only +60bps on yesterday’s session while "shorts EXPLODED HIGHER", negatively offsetting the furious move higher in “longs”—especially in-light of the previously discussed "low net" exposure for HFs.
And while we commented on yesterday's furious squeeze yesterday, here is some additional context on the scale of the short squeeze:
- Largest 2d move in “Default Risk” factor shorts (+7.0%) since 2010
- 3rd largest 2d move in “ROE” factor shorts (+8.4%) since 2010
- Largest 1d move in “Sales-to-Price” factor shorts (+3.5%) since Nov 2011
- 3rd largest 1d move in “EBITDA / EV” factor shorts (+4.2%) since Nov 2011
- Largest 1d move in “Book-to-Price” factor shorts (+2.7%) since Aug 2015
- Largest 1d move in my HF Most Shorted basket since Feb 2018
- Largest 1d move in GS Most Shorted basket since Nov 2016
- Largest 1d move in Citigroup High Short Interest basket since Apr 2015
To summarize, McElligott explains that "you saw a dynamic yday in the Equities quant “factor” space, where you actually only saw “outright modest” performance from “Growth” and “Momentum” market-neutral strategies, as the short-legs mitigated long-book gains."
The last observation has become a recurring issue for traders, who while continuing to underperform the market badly YTD...
... remain overly "hedged" to any future upside, and as a result during furious rallies like Tuesday's, are not only forced to cover shorts more aggressively than pursuing new longs resulting in dramatic squeezes, but further add to their general market underperformance as the adverse impact from forced covering overpowers the long benefit.
Meanwhile, what happens the very next day - like today - is that as the market resumes its slide, many hedge funds suddenly find themselves with not enough shorts on, and are forced to do a 180, and start shorting once again as the year-end performance scramble result in a furious panic to chase every last tick of the market.