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Hedge Funds Net Leverage Highest In Over Two Years?

US recovery

EDITOR NOTE: The market bull is advancing on steroids. Not only are smaller investors piling into the market in droves, they’re doing so on high leverage, many using derivatives (like option calls) to amplify their bets. Several hedge funds, especially those who were betting on a falling market, are now taking major losses; forced to close their “short sale” positions at increasingly higher prices. The question is, how much of the current market is simply a short squeeze? Is there real fundamental substance behind the rally, or is it a blow off of short-covering?

On Friday we officially entered the blow-off top phase of the current meltup: between a record surge in Nasdaq volume...

... between a spike in equity call volumes to a decade high...

...and a put-to-call ratio that plunged just shy of all time lows...

... the message was clear: the moment of trader euphoria and buying from retail investors (who as we noted previously managed to lift bankrupt Hertz by 100% on record volumes earlier in the day) so many bulls have been saying is not here so just keep buying as retail froth is missing from the market. Well, it certainly isn't missing any more, as "small traders are now full-bore bullish, on steroids" (thanks Fed).

Well, it's not just retail investors anymore: according to Goldman's PB desk, after holding out for months hedge funds finally capitulated and are now also flooding into stocks.

In its latest weekly exposure report, Goldman's prime desk notes that while overall hedge fund gross leverage fell -2.5 pts to 247.1% (96th percentile one-year), net leverage rose +1.0% to 75.0%,  the highest level in over two years.

This happened with hedge funds scrambling to cover even more shorts as the MSCI World Index increased +3.3%; as a result the GS Prime Brokerage Book was net bought driven by short covering outweighing long selling in a 2.4:1 ratio, confirming what Citi said recently that much if not all of the recent rally has been driven by short covering.

Digging into the flow data reveals that all regions were net bought led by Europe and North America.   

  • North America was net bought driven by “risk off” flows – short covering and long selling. Europe’s net buying however was characterized by “bullish” flows – long buying and short covering.
  • North America’s weight vs. the MSCI decreased -0.6 pts to +2.6% O/W (91st percentile vs. past year), while Europe’s weight rose +0.4 pts to -4.0% U/W (40th percentile vs. past year).

At the sector level, funds again faded the rally in US Industrials even as cyclical stocks soared. The sector was the second most net sold in the US driven by "risk off" flows of long selling outweighing short covering in a 1.2:1 ratio. The sector’s weight vs. the S&P 500 fell -0.7 pts to -1.5% U/W, the lowest level since Sept 2017 according to Goldman's prime desk.

While seven out of the eleven Industries were net sold driven by Aerospace & Defense and Construction & Engineering, Airlines and Commercial Svcs & Supplies were the most net bought industries (so it wasn't just retail flooding in JETS).

Focusing on the short squeeze, single stock shorts decreased by -2.1% as nine out of eleven sectors were covered led by Consumer Discretionary and Industrials. Utilities and Real Estate were the only shorted sectors. Consumer Discretionary flows diverged – inflows were led by Diversified Consumer Svcs, while outflows were led by Leisure Profucts.

US ETF shorts decreased -2.6% and currently make up 16.5% of the US Short Book (vs. 16.9% last week).

ETF short outflows were driven by Fixed Income, US Listed, and Small and Large Cap ETFs.

Finally, at the single stock level, some of the most prominent hedge fund rotations were the following:

  • Royal Caribbean (RCL) shorts increased +17% as shares rose 12% amid the pricing of a debt offering
  • Slack Technologies Inc (WORK) shorts increased +36% as shares rose 17% amid Q1 earnings
  • Inovio Pharmaceutical (INO) shorts increased +16% as shares fell 11% amid continued Covid19 Vaccine trials

Originally posted on ZeroHedge

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All articles are provided as a third party analysis and do not necessarily reflect the explicit views of GSI Exchange and should not be construed as financial advice.

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