One of the biggest buyers of U.S. stocks has turned so bearish that a growing number of investors say it can only mean one thing: buy.
Hedge funds that aim to profit from global economic trends -- a group that oversees some $550 billion -- spent the past month putting on trades that would profit from a decline in equities. As a result, such “short” positions exceed bullish ones by 22 percentage points, their most pessimistic stance since January 2009, Credit Suisse Group AG says.
Traders are salivating over the thought of all that money from so-called macro funds flowing back into equities, especially if the market proves resilient to higher interest rates imposed by the Federal Reserve. The Standard & Poor’s 500 Index has gone almost four years without a decline of 10 percent or more, the third-longest stretch ever.
“There is perhaps no better positive short-term indicator for stocks than a surge in bearishness,” said Howard Ward, chief investment officer of growth equities at Mario Gabelli’s Gamco Investors Inc., which oversees $45.4 billion in Rye, New York. “Virtually every effort to time this market for the past six years has failed. This one likely will fail too.”
The last two bouts of bearishness by macro managers preceded rallies. Funds went short as equities were tumbling in March, just before a rebound pushed the S&P 500 back to a record. It also happened in the first quarter of 2014. The S&P 500 dropped as much as 5.8 percent through February only to bounce back to all-time highs at the end of the month.
The benchmark index rose 0.5 percent at 4 p.m. in New York, erasing an earlier loss of 0.6 percent.
An abundance of skepticism is one reason for the resilience in equities. Going short requires the sale of borrowed stock, which then must be bought back at a later date and returned for the trade to be completed. Short covering was in evidence during rallies on Aug. 10 and Aug. 12, when a Goldman Sachs Group Inc. index of stocks favored by bears rose twice as fast as everything else.
A rush to the exits by the biggest speculators was a hallmark of the last two U.S. equity selloffs, something that might be avoided with exposure pruned.
In April 2014, as shares were enduring the largest weekly decline in two years, companies in which hedge funds had the highest concentration of ownership bore the worst of the selling. The same thing happened in October, when favorite stocks such as Ally Financial Inc. and Zynga Inc. fell twice as fast as the S&P 500.
The recent shift from U.S. stocks is part of a broad rotation out of risky assets, according to Ethan Powell, chief product strategist at Highland Capital Management in Dallas.
“It’s more of not exposing yourself to the risk that’s very difficult to handicap versus having a definite bearish stance,” said Powell, whose firm oversees $21 billion. While hedge funds know the Fed will raise rates, “they don’t have a high degree of conviction in how the market will necessarily respond.”
Macro managers, hurt in recent years by central bank stimulus that has suppressed volatility, are trying to make up for the mistake as equity breadth worsens and the Fed is poised to raise rates from near zero as soon as next month. This is only the third time since 2011 that their bearish bets have exceeded bullish ones, Credit Suisse data show.
“The majority of managers sold out their long position and replaced it with a similarly sized short,” said Mark Connors, Credit Suisse’s global head of risk advisory in New York. “They’re cutting aggressively. That’s a directional play.”
One reason for the pullout from U.S. stocks is that central banks in Europe and Japan are adding stimulus, according to Arvin Soh, a New York-based portfolio manager who develops global macro strategies at GAM. Macro funds are shorting the U.S. as either a hedge or a relative trade to amplify returns, he said.
“When you hit the point in which one central bank is expected to raise interest rates while the other central banks are expected to lower rates, that’s not usual,” said Soh, whose firm oversees $130 billion globally. “It’s that dichotomy, that shift that’s causing that big of a move.”
While the S&P 500 is up 2.1 percent this year, the Stoxx Europe 600 Index and the Topix of Japanese shares have rallied at least 13 percent in local currency terms.
The S&P 500 has traded within an 8 percent band in the past nine months. Since 1927, the market had hewed to such a range just three times, data compiled by Bloomberg show. On two out of these occasions when the pattern began, in 1991 and 1965, the index advanced 12 months later, with gains averaging 8 percent. The third time was in October 1972 when the S&P 500 was down 1.5 percent a year later.
“When sentiment gets short-term bearish, it’s usually a good contrarian signal because the underlying backdrop for U.S. equities is still a robust story,” said Jeffrey Yu, head of U.S. single stock derivatives trading at UBS AG in New York. “What the market really tells you is that once we break out, it should be a meaningful move.”