No Short Squeeze Here: S&P 500 Was Due For A Rally

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Short Squeeze? The S&P 500 rallied last week and continued to gain on Monday after a tough start to the year, and because of how suddenly U.S. stocks turned around, there were murmurings about a short squeeze. However, Deutsche Bank analysts say this is definitely not the case and that equity funds in the U.S. were positioned at nearly neutral before the index’s rally rather than underweight, as some thought. Today the S&P 500 is off to a weak start, however, so we could be seeing a turnaround. As of this writing, the benchmark index was down 0.77% at 1,930.60

Of course they also said there were and are still some pockets of significantly sized short interest, such as in index and exchange-traded fund futures, plus cash.

U.S. equity positions move to long on positive surprises

Deutsche Bank strategist Parag Thatte said that now positioning in U.S. equities has shifted from neutral to long, which certainly doesn’t indicate a short squeeze. He added that the rally in U.S. equities has been synced with the recent positive surprises (such as labor, retail and production) in U.S. macroeconomic data. This is particularly significant because there have been negative data surprises consistently over the last 14 months, which they say was worse than any time other than in 2008.

Further, the bank’s surprise index shifted suddenly from deeply negative to neutral, supported by the U.S. dollar’s dip. Thatte and team found a massive 65% negative correlation between the U.S. dollar’s moves and the recent data surprises. They believe that the future of data surprises and whether they head to the historical band’s top and “complete a typical cycle” hangs on whether the dollar stabilizes or falls further, which they view as the more favorable option.

Short Squeeze

Equity outflows slow

Looking at demand /supply flows, the Deutsche Bank team said the S&P 500’s rally also coincides with a return of buyback bids as the end of the fourth quarter earnings reporting period nears its close. Also positioning has moved up, and U.S. equity outflows have slowed modestly. They add that equity flows are also typically tied with data surprises, although thus far they have been running behind the historical relationship between the, which suggests that outflows are beginning to cease.

Short Squeeze

Meanwhile the “large” risk aversion rotation from U.S. equity outflows and credit to Treasuries and cash continues.

Short Squeeze

Thatte and team said that within U.S. equities and the S&P 500, investors are upping their mutual fund, long-short hedge fund and asset allocation fund exposures.

Short Squeeze

Meanwhile they’re avoiding macro-focused hedge funds as exposure to them remains underweight. European funds have also slashed exposure dramatically to become underweight, and Japanese funds are also pulling back on their overweight positioning.

Short Squeeze? Still some short positioning

Of course there will almost always be shorts in some areas, and the Deutsche Bank tem explains that bond future shorts continue in 2-year, 5-year and “very long-dated bonds,” although 10-year bond exposure is close to neutral.

Short Squeeze

However, bond funds managed to outperform last week as high-yield bounced. Inflows at fixed income flows remain muted, although they noted a move into government and municipal bonds and mortgage-backed securities, meaning investors are shifting toward riskier investments. Meanwhile they’re moving from credit.

Short Squeeze

They describe the U.S. dollar’s turnaround as “broad-based and well advanced” as investors unwind the positions they added since the adoption of negative rates by the European central bank. They observed that aggregate longs and shorts in the dollar versus the euro have returned to where they were in June 2014, while the yen is still close to four-year highs after investors turned long last month, marking the first time they did so in more than three years.

The Australian dollar is now long, and investors are trimming their shorts in the Canadian dollar. Shorts in the peso are back up to high levels on the back of Banxico’s surprise interest rate high and other support moves.

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