(Bloomberg) - Big-money speculators are shunning the new-year equity rally, unconvinced by the buying frenzy that has swept across the retail crowd as well as corporate America.
While being forced to unwind bearish bets in droves by last week’s risk-on rotation, hedge funds tracked by Goldman Sachs Group Inc.’s prime brokerage have been reluctant to chase market gains. Their long positions were trimmed during the week through Thursday as the S&P 500 Index posted its fourth weekly advance in five.
The reduction in both long and short positions — a phenomenon known on Wall Street as de-grossing — led to the largest overall retreat since January 2021, when day traders infamously banded together on Reddit to take on professional short sellers.
Further evidence of professional investor caution was evident in data compiled by JPMorgan Chase & Co., showing Thursday marked the 10th-biggest de-grossing session since the start of 2018. Combined with long activity, the firm’s prime brokerage noted flows were “quite negative” over the past four weeks.
While hedge funds are well known for their defensive exposure — a tilt that allowed them to fare better during last year’s selloff, the tentative positioning speaks to a lingering sense that the S&P 500’s roughly 17% gain from October may have gone too far given the Federal Reserve is still in tightening mode and corporate profits are falling. The lack of faith contrasts to a market where corporate buybacks are starting off the year at a record pace and the retail army is boosting its presence in stock trading above the meme-era peak.
“The equity guys are pretty shell-shocked and are not behaving with that kind of conviction,” said Benjamin Dunn, president of Alpha Theory Advisors. “If you look at the sell side, it’s all pretty uniformly bearish.”
The strength of the new year’s market shift took hedge funds by surprise. While their favorite longs have beaten the S&P 500 by 4 percentage points this year, their most-shorted stocks have handed them losses by outperforming by a whopping 17 percentage points, Goldman’s indexes show. Put altogether, global long-short stock funds have hung onto a 4.5% return while sheer price gains have lifted the value of their positions.
Stocks fell for a second session Monday, extending a retreat after Friday’s hot jobs report. At its high of 4,180 last week, the S&P 500 was already ahead of the average year-end target from Wall Street strategists tracked Bloomberg — by 3.2%.
Hedge funds, heading into 2023 with low equity exposure, are scrambling to unwind short positions as January’s equity rally defied warnings from prognosticators at firms like Morgan Stanley and JPMorgan that the going will get tough in the first half. Amid the Nasdaq 100’s best start to a year in two decades, funds tracked by Goldman quickly slashed their bearish bets in technology shares, with short covering hitting the fastest pace in two years, data compiled by the team including Vincent Lin show.
Such covering may have added fuel to the market rally, luring more investors to join the party. Rules-based computer-driven funds such as trend followers, for instance, have gobbled up $95 billion to $100 billion of stocks this year, with January’s purchases marking the heaviest since November 2019, according to an estimate from Morgan Stanley’s trading desk.
As things stand now, net leverage — a measure of hedge-fund risk appetite that takes into account their long versus short positions — has climbed from the start of the year, in part thanks to short covering. Yet at 69%, it still sits in the bottom quarter of a three-year range, Goldman’s data show. Readings on fund exposure at Morgan Stanley and JPMorgan also pointed to a lack of euphoria, especially among US managers.
“There could be some residual de-grossing, but the medium-term metrics suggest we could be closer to the end than the beginning,” JPMorgan’s team including John Schlegel wrote in a note. “Additionally, as de-grossing/short covering have often reversed as markets pulled back from highs, this could be another sign that the market rally might need a breather.”
By Lu Wang and Justina Lee
