Hedge funds and asset managers have raised their bets against the US stock market to their highest level since 2011, driven by fears about a possible US debt default and a recession.
Net short positions — bets on price falls — held in derivative contracts linked to the S&P 500 have increased sharply in recent weeks, according to a Société Générale analysis of a combination of futures positions from the US Commodity Futures Trading Commission.
Investors have been racing to protect their portfolios as the US edges closer to a debt default, with president Joe Biden warning Republicans in Congress that a failure to reach a deal to raise the government’s $31.4tn borrowing limit would be a “catastrophe” for the economy.
Despite the debt concerns and the collapse of several US regional banks in the spring, the S&P has risen 8 per cent this year, hitting an eight-month high earlier this week and fuelling hopes that a new bull market has already begun on Wall Street.
The market’s rise “seems misplaced given that investors were never pricing in a material risk of failure to raise the debt ceiling to begin with”, said Marko Kolanovic, a JPMorgan strategist.
Société Générale described the high level of short positions as a warning signal that is “too strong to ignore”.
US politicians are looking to finalise a deal on the debt ceiling in the coming days, ahead of June 1 when the US could run out of cash to pay all of its financial obligations.
Many managers are also concerned about valuations on US equities and the possibility that the rapid rises in interest rates by the Federal Reserve over the past year to try to fight inflation could trigger a recession.
The S&P 500 is currently trading on a price to forward earnings multiple of 18.7 times, towards the top of its historic valuation range.
“Equities seem somewhat expensive to us. Price [to] earnings ratios are close to historic highs,” said Kenneth Tropin, chair of Connecticut-based Graham Capital Management, which runs $17.7bn in assets. He said his firm’s traders had been running a small short position for much of this year, although these had been cut back because of the rally in stocks.
“Given a rally driven by only a handful of names, relatively expensive valuations in technology companies and large-cap growth stocks, and the negative impact of credit tightening on company earnings, we expect higher volatility in the months ahead and see the S&P 500 at around 3,800 by December,” said Mark Haefele, chief investment officer at UBS Global Wealth Management. On Friday the index was about 4,175.
Many hedge funds have been buying individual stocks with strong cash flow, while also putting on short bets against the overall market, reflecting their caution, according to Mario Unali, a portfolio manager at investment firm Kairos.
“Conviction in a broad-based risk rally remains muted due to the uncertain economic environment,” he added.
Some in the market believe that problems in stock markets could start to be felt later in the year, particularly if interest rates stay higher than markets expect.
Michael Wilson, chief US equity strategist at Morgan Stanley, said an earnings recession was approaching in the second half of this year as consumer spending was beginning to slow and the problems affecting regional banks would accelerate the tightening in the availability of credit for US businesses.
“The major [US equity] indices are priced for simultaneous good outcomes on multiple fronts whereas we think risks are elevated and even increasing in some instances,” said Wilson.
“My best guess is something during the second half of the year we could see a good size correction in equities if the Fed disappoints those who believe they will be cutting rates three times before year end,” said Graham’s Tropin.
