This morning, Bloomberg reported on short interest in U.S. equity markets reaching levels not seen since 2008, with the suggestion that this could serve as a contrarian set up, quoting Fundstrat Global Advisor’s Thomas Lee, who opined:
“There’s an enormous demand coming,”
“Retail investors are about to put a lot of money into the equity markets because they’re trend followers and the S&P has had two positive quarters in a row. Funds can’t keep a trillion short position, larger than March ’09.”
This all makes perfect sense, especially when you consider the factor that the U.S. stock market has overcome every short term obstacle since the financial crisis. In the age of ZIRP and QE, no matter how bad market sentiment, cash positions or short interest got, a v-bottom followed.
The Fed chair’s recent dovish tone flies in the face what has been better than decent domestic economic data of late, now placing a heavy emphasis on external factors. Most importantly, the Fed reversed course on the pace of rate increases in Q1 as a result of strains outside the U.S. causing volatility in our markets and providing potential headwinds to U.S. growth. Obviously most of these strains abated in the second half of February and early March, causing a fairly epic rally in the S&P 500 (SPX), equaling about 13% from its February 11th low.
As regular readers know, it’s my belief that despite the recent rally, the SPX’s inability (for now) to make a new high (at least above the November highs), suggests that the largest equity index in the world is in a topping pattern, with last week’s high after Yellen’s dovish commentary marking its second significant lower high since last May’s all time highs:
The green circle above that makes me to believe that it could be different this time. That after 7 years and more than 200% gains from the 2009 lows, the SPX finally did something it had not done since 2008, made a new lower low (Feb V bottom low was lower than Oct 2014 V bottom low).
As for those strains that caused the Jan/Feb equity volatility. Crude Oil is down 12% from its 4 month highs made on March 22nd, the European Bank Index (SX7E) is down 22% from its March highs, and up only 8% from its 52 week lows, the high yield debt etf HYG is approaching a key breakdown level from mid December at $80, the yield on the 10 year U.S. Treasury Yield is at 1.75%, the Japanese Nikkei is down 17.50% on the year, the Shanghai Composite is down 14% on the year, copper is down about 8.5% from its 2016 highs and up only 9% from its January lows, all this with the U.S. dollar actually dropping, with the DXY down nearly 4% in 2016.
So maybe that trillion dollar short position will be the impetus for the SPX to make a new all time high in the coming months, and this could definitely be in the cards if the Fed uses external excuses to remain accommodative, despite improving data in the U.S. If this stance from the Fed was accompanied by the dollar breaking below the 15 month range it has been in, then I suspect with 10 yr yield below 2%, shorts will cover, and maybe even get long, as U.S. stocks will once again be the only game in town. If that were to occur, then if you think U.S. stocks are expensive now, then they would be in full blow bubble territory without a meaningful increase in earnings growth, which as of now is already in a recession.