The running of the bulls continues on Wall Street as signs point to the bullish hedge fund positioning that was in place before the FOMC and BoJ comments earlier this week still being in place now. Indeed, it seems as if investors are unconvinced that the U.S. Federal Reserve will follow through with past hawkish statements and seeming “promises” of rate hikes. This time anyway, they were right.
Hedge funds still bullish despite market selloff
Morgan Stanley Prime Brokerage strategist John Schlegel and team released their latest “Hedge Fund Positioning Update” on September 20. They reported that hedge fund flows were generally skewed toward buying going into the Federal Open Market Committee and Bank of Japan meetings.
They added that this “modestly bullish” trend has been going on since the middle February and when looking at a longer term chart, the volatility observed earlier this month is hardly noticeable. In fact, hedge fund flows have remained skewed toward buying despite the exchange-traded fund hedging that occurred during the market selloff that took place between September 9 and 13.
[drizzle]Even Japanese equities have been net bought since the middle of February as well.
Hedge Fund Positioning – Fed to keep rates lower for longer
In his September 22 “Breakfast with Dave” note, reputed economist Dave Rosenberg of Gluskin Sheff noted that markets had not really been expecting the Federal Reserve to hike going into this week’s meeting. In fact, he said the markets had priced in only a 20% chance of a rate hike.
“Three hawkish dissents did not through the bulls off course” he added. “Nor did the press statement which left December rate-hike odds a tad above 50%.”
He explained that the “dot plots” set forth by the Fed removed the likelihood of a rate hike next year or next year and left the expected funds rate 50 basis points lower than where it was estimated to be three months ago. In other words, it lowered the rate from 2.125% to 1.875%. Also the terminal funds rate was slashed again, from 3% to 2.755%.
According to Rosenberg, “Lower for longer on rates was all over the Fed’s commentary.”
Hedge Fund Positioning – Long/ short ratio movements mixed
In keeping with the bullish hedge fund flow trends, the Morgan Stanley team also observed earlier this week that compared to the recent past, the long/ short ratio is high. However, looking out over the long term, it actually isn’t.
Their Global Long/Short ratio is the ratio between the total global long and short exposures across all of the various hedge fund strategies. They report that this ratio is hovering around the highest levels they have observed in a year but remains far below the highs they observed in 2013 through the first half of 2015.
The Morgan Stanley team added that the ratio’s six-month z-score registered “fairly extreme levels” beginning at the end of July and warned that when this has happened in recent years, “modest” global equity pullbacks have occurred.
However, they see little cause for concern right now, despite the fact that the last time the z-score was this high and the long/ short ratio was this low was in the middle of 2009. Because of what happened in 2009, it might make sense to expect another major pullback in the near future and hedge fund flows might shift back to selling.
In this particular case though, they don’t see hedge funds as being “extremely” bullish, which is why they see a lower risk of a repeat episode.