hedge fund leverage just shy of 2007 peak BAML

Hedge fund Leverage, as measured by NYSE Margin Debt, rose slightly by 0.6% month-over month (MOM) to $366bn in February, compared to the July 2007 peak of $381 billion. The data comes from a new note issued by BAML. BAML analysts noted in a previous note that leverage had hit $364bn in January.

leverage can be used as a contrarian 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.

Other key findings from BAML

Net Free Credits from the NYSE Margin Debt data generated a sell signal in January, as flagged in Hedge Fund Monitor, 04 March 2013. Net Free Credits are essentially a measure of cash levels in margin accounts. Since 1992, 14 sell signals have been generated. Historically, the signal tends to delay by one month if the absolute return of S&P 500 is more than 5% in the signal month – which was the case for January. This is a risk for the US equity market in April.

Examining Hedge Fund positioning by major strategies

BAML models indicate that Market Neutral hedge funds bought market exposure to 7% net long from 2% net long. Equity Long/Short bought market exposure to 25% from 23% net long, well below the 35-40% benchmark. Macros continued to sell the S&P 500, NASDAQ 100, and 10-year Treasuries, continued to buy USD, and aggressively bought commodities. In addition, they partially covered their shorts in EM and EAFE.

Significant HF moves across asset classes based on CFTC data

Equities: Large specs sold the S&P 500 and Russell 2000, and bought NASDAQ 100 futures into a crowded long. S&P 500 remains in a crowded long.

Agriculture: Large specs sold soybean & corn, and added to their shorts in wheat. Readings are neutral.

Metals: Large specs sold gold & silver, bought platinum & palladium, and added to their shorts in copper. Gold moved back into a buy zone; Palladium stays in a crowded long and Silver remains a buy zone.

Energy: Large specs bought crude oil & heating oil, sold gasoline, and partially covered natural gas. Crude remains in a crowded long.

FX: Large specs maintained a crowded long in USD, partially covered Yen & added to their shorts in Euro.

Interest Rates: Large specs partially covered 30-yr Treasuries, bought 10-yr, and sold 2-yr Treasuries. 10-yr is approaching a crowded long.