Short Covering Caught Hedge Funds in July Near Record levels – Goldman Sachs

The sometimes-vertical moves in stocks during July, in particular in the Magnificent Seven Stocks caught many hedge funds by surprise in July according to Goldman Sachs Prime Brokerage. Goldman Sachs indicates “signs of capitulation are starting to emerge” in their recent prime brokerage report. To be fair many of the analysts have been arguing capitulation was nigh for at least six months it seems. While losses were mainly on the short side Goldman saw “a meaningful deterioration in long side” also.

Highlights from the report were:

  • Hedge funds have been de-risking in July at levels that are close to record levels for the past decade.
  • The de-risking by hedge funds in July has been mainly attributed to short covering.
  • Long/short hedge funds experienced nine consecutive days of negative returns before July 28, which is the longest streak since January 2017.
  • Long/short hedge funds are expected to face the worst monthly alpha drawdown in July since May 2022.

The result from Goldman Sachs was no suprise to the KnovaWave desk as covered at TradersCommunity which I reprise below:

When Markets Get Short Behind the Curve

Worth reading again what fueled the recent rally…

We analyzed the short component of this year’s rally back in May and it an important component of the market’s structure. Global stocks have continued to climb the wall of worry in 2023, with what has become a series of saves from the brink of economic disaster in a political episode worthy of the best Monty Python minds. The end result has left many investors over insured at times as we have been focusing on with option saturation, short bets and long only investors out of the market. The latter in a rising market essentially makes them short.

This background is not new we have seen it many times over the last 20 to 30 years. The difference here is the sheer weight of money in the system and the introduction of shorter dated options and so many playing it.

Speculators and hedge funds had put on the largest short positions in the S&P 500 since 2007 according to Bespoke Investment Group using CFTC data measured as a percentage of open futures-market interest.

At the same time, they have bet long on the Nasdaq-100, with net bullish plays nearing the highest levels since late last year, remember that. Markets go where the most pain is. The move, in a world where averaging your position is seen as trading has fueled larger positions. Anyone understand the martingale principle?

Fed Assets expanded $364 billion over three weeks in March in banking crisis liquidity operations (the market has a short memory that was only 8 weeks ago and helped create bigger shorts out there). Assets remain about $45 billion above the March 1st level. FHLB assets expanded an unprecedented $317 billion during Q1 ($802bn over 4 quarters). Indicative of the liquidity surge, money market fund assets inflated $384 billion in the five weeks beginning March 8th. In affect we got a massive boost a surge in financial sector Credit with those FHLB money market borrowings to finance its massive banking liquidity support operations.

Source: TradersCommunity, Goldman Sachs

From the TradrsCommunity Research Desk