Big Short in Stocks Is Almost Over After $300 Billion Unwind

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(Bloomberg) — Money managers have cut $300 billion of bearish bets and are now positioned more in line with historic norms — robbing the market of pent-up demand just as the Federal Reserve warns its inflation-fighting battle is far from over.

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The shift in positioning has taken a broad array of investors from underweight to holding equities closer to the average of the past decade. Investors are now the closest to neutral positioning than they have been since the second quarter of last year, when the Fed began ramping up interest rates, according to data from JPMorgan Chase & Co. and Deutsche Bank AG.

That sentiment shift, as the S&P 500 surged from its bear-market low in mid-October, suggests stocks may have trouble pushing higher unless the funds turn outright bullish. So far — aside from some systematic funds that have been forced to raise exposure — most managers remain wary of another market selloff given hawkish central bankers risk stoking a recession. A chorus of monetary officials warned Wednesday that they are far from done with policy tightening, a day after Chair Jerome Powell again cheered signs of disinflation.

“Equity investors have an innate ability to pick and choose strands from the macro narrative which support their Pavlovian instincts,” said James Athey, investment director at Edinburgh-based abrdn. “We are now entertaining the notion of ‘no landing’ a somewhat pie-in-the-sky belief in the ability for the economy to disinflate without negative growth consequences.”

The risk-on climate that’s propelling the most speculative assets and putting the Nasdaq 100 on the verge of a bull market has proved hard to resist in recent weeks. Powell did little to spoil the good mood this week, though stocks slumped Wednesday.

The new-year surge forced many investors who had expected a slow start to cover bearish positions. A basket of the most-shorted stocks tracked by Goldman Sachs Group Inc. has gained 21% as the S&P 500 added almost 8% so far this year.

“Our equity futures positioning proxy has moved closer to the middle of its historical level suggesting that the previous equity shorts or underweights of last October have been largely covered,” said JPMorgan strategist Nikolaos Panigirtzoglou.

He estimates investors have unwound $300 billion of bearish positions, whether it’s shorts or underweight exposures, based on a model tracking changes in open-interest data on index futures and positions from momentum traders. The swing is more like $120 billion when it comes to US equity futures, per Panigirtzoglou. JPMorgan’s positioning proxy jumped to 9% on Tuesday, compared with a low of minus 9% in October. A reading of 15% is considered neutral.

Markets remain convinced in a Fed pivot to easier policy, despite labor gains that are topping the most optimistic forecasts. Meanwhile the likes of Goldman Sachs Group Inc. strategists raised short-term targets for US equities and downgraded the chances of recession to 25% — down from 35%.

Still, many on Wall Street warn the new year exuberance may be overdone and will flame out in a replay of 2022’s bear-market rallies. Though they joined the ranks of forced buyers reducing shorts, hedge funds trimmed long positions at the same time in a dynamic known as de-grossing.

Read: Hedge Funds Cut Bets in Largest Unwind Since 2021 Short Squeeze

Leveraged funds have moved closer to neutral. But within the category there’s a divergence between systematic funds, such as trend followers, that have flipped to an outright overweight, and their discretionary peers who are still underweight, JPMorgan’s data show.

Meanwhile individual investors have also returned to buying after a year of depressed activity. Trading orders from the retail army in stocks and exchange-traded funds accounted for 23% of the market’s total volume in late January, above the previous high of 22% reached during the 2021 meme mania, according to JPMorgan estimates derived from public data on exchanges.

“For equities overall we would say most of the increase has come from systematic strategies,” said Parag Thatte, a strategist at Deutsche Bank. “Discretionary positioning overall has moved much less.”

–With assistance from Lu Wang.

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