Market Radar 24. April 2023

Hedge fund managers are in a “betting bind”.

In March, hedge funds significantly expanded their short positioning in U.S. equities: short sales of over $40 billion were set up, so that the short selling ratio of these institutional professionals is currently likely to be around one trillion USD. This is a high rate that was last observed historically about twenty years ago and usually occurred when the major US stock indices were close to significant lows in terms of charts.

However, this is currently not the case:
The Dow Jones Industrial Average is trading about 19% above the fall low of 2022.
The S&P 500 is also trading about 19% above the fall 2022 low.
The Nasdaq 100 is trading about 25% above the fall low of 2022.

The short-positioned hedge fund managers are currently betting on a future downward movement and are not reacting to such a move – as for example in the spring of 2003 or at the beginning of the pandemic in March 2020. However, because this bet can now be seen by any well-informed stock market trader, the bet is unlikely to work out.

Bets only work if the bettor is not a contributor. Sorry. That is not quite the right way to put it. Actually, it should be said here: Bets only work if the participation is not exposed. As long as betting fraud is not discovered, bets can be won. However, since the involvement has already been “exposed”, hedge fund managers are now likely to be in a tight spot. Their most pressing question now is: how do we get out of the short positions as unscathed as possible?

A crash is therefore not to be expected in the US stock market just because the institutional investors are bearishly positioned – at least the short positions of the institutional investors are unlikely to be able to cause a crash through their positioning alone. In the past, such high short positions could often – but not always – even be used as good countercyclical buy signals.

U.S. Treasuries were increased in March as rarely
Fund managers who do not want to take short bets or are not allowed to do so under internal investment restrictions also avoided buying stocks in March: instead of shorting equities, they massively increased US government bonds. This was recently revealed by Bank of America’s monthly survey, in which 212 portfolio managers worldwide took part in March.

Credit risk dominates outlook for the US economy
According to this Bank of America survey, for the first time in nine months, inflation concerns are no longer rated as the biggest risk to markets. Instead, concerns about systemic credit risk came first: if banks cut back on lending, this could increase fears of recession.

More than 60% of global fund managers expect the US economy to deteriorate; the possibility of a no landing, i.e. a successful circumnavigation of the recession, is only granted by a few fund managers. For example, those who do not consider “no landing” to be excluded refer to interviews they have conducted with CEOs of medium-sized companies where the production process is subject to cyclical fluctuations. These CEOs report that there is a lack on the supply side and not on the demand side. Their companies would like to produce more if they could. As soon as supply chain problems, raw material shortages and energy supply costs do not burden the production chains to a greater or lesser extent, the post is likely to go off on the production side – provided that demand for the products has not decreased in the meantime. But that, in turn, would have the effect of restricting lending.
U.S. gross domestic product for the first quarter is expected to officially be around 2.5%.

This trading week, the official US gross domestic product figures for the first quarter of 2023 will be released. The so-called GDP Now survey published by the Federal Reserve Atlanta recently forecast growth of 2.5% for the first quarter. The final survey is likely to be roughly within this range – which will then be binding on the US government and the US Federal Reserve for monetary policy guiding principles.

The GDP forecasts will only be exciting again when the Federal Reserve Atlanta publishes the first surveys for the second quarter, which is expected at the beginning of May. 

Only if I see a decline in GDP towards 0% would I rule out a “no landing”. Not before. Economic growth combined with falling inflation would be a great opportunity for all those who are currently long in equities and want to stay that way. The best part is: only a few bet on it.