Hedge fund leverage 1992-2007

Hedge Fund Monitor’s latest edition reveals some scary data about hedge fund leverage. BAML, which puts out the report weekly notes that hedge fund leverage is up 32% year over year.  We earlier noted that hedge funds are back to shorting the Euro due to concerns regarding Italy. Some data regarding NYSE margin debt followed by a summary of other key points below from BAML:

Net Free Credits from the NYSE Margin Debt data shown in the chart above is essentially a measure of cash levels in margin accounts. Current levels have fallen to levels that have generated a tactical sell signal based on a 2-standerd deviation Z-Score reading. The last time a sell signal was generated was on April 2010 and the S&P 500 (S&P Indices: .INX) subsequently corrected by 16% in two months. Net free credits for January were at a negative $77.2 million or cash balances are negative and the Z-Score indicates the cash draw down has been excessive. So a contrarian sell signal is given.

Leverage, as measured by NYSE Margin Debt, rose 31.6% year-on-year (YOY) and 10.2% month-over-month (MOM) to $364bn in January, compared to the July 2007 peak of $381bn. Leverage can be used as a sentiment indicator because it is related to investor confidence. It tends to be correlated to the direction of the equity market – investors are likely to gain confidence and add leverage when the equity market is going up and vice versa.

Current readings indicate that investors are becoming more confident in the equity market, which generally supports further upside. Just short term levels have gotten a bit ahead of themselves with cash levels now drawn down to levels which typically result in market correction.

Other key points

Hedge Funds continue to underperform the equity market. February flash return was up 0.33% as of Feb 27, compared to a price return of 1.19% for the S&P 500 (S&P Indices:.INX).

10-year Treasuries move into a crowded long; Wheat to crowded short. The last time large specs reached this level of shorting wheat prices bottomed one month later and rallied 36%.

The investable hedge fund composite index was up 0.33% for February as of February 27 2013, compared to a price return of 1.19% for the S&P 500 (S&P Indices:.INX). Convertible Arbitrage performed the best, up 1.23%. CTA Advisors performed the worst and were down 0.55% for the same period.

Examining Hedge Fund positioning by major strategies

BAML models indicate that Market Neutral funds bought market exposure to 1% net long from 4% net short. Equity Long/Short held market exposure steady at 33% net long, just below the 35-40% benchmark. Macros aggressively bought the S&P 500 (/INX), NASDAQ-100 (INDEXNASDAQ:NDX) & 10-year Treasuries, sold commodities, and added to their
shorts in USD. In addition, they added to their shorts in both EM and EAFE.

Significant Hedge fund moves across asset classes based on CFTC data

Equities: Large hedge funds sold NASDAQ-100 (INDEXNASDAQ:NDX) futures, were flat the S&P 500 (S&P Indices: .INX), and bought the Russell 2000.

Agriculture: Large hedge funds bought soybean, sold corn, and added to their shorts in wheat. Wheat moved into a crowded short.

Metals: Hedge funds bought gold, sold silver & copper, slightly sold platinum and were flat palladium. Gold remains in a buy zone. Palladium is in a crowded long.

Energy: Hedge funds sold crude oil, heating oil & gasoline, and were flat natural gas. Crude oil & gas remain in a crowded long; heating oil moved out of a crowded long.

Interest Rates: hedge funds aggressively bought 10-yr & 2-yr Ts, and are essentially flat in 30-year Ts. 10-year Ts moved into a crowded long.