Short squeeze pain, bigger picture intact

Eleanor Creagh

Australian Market Strategist

Summary:  Fresh of a series of record highs last week, the risk rally and recent reflation focus has hit pause. The epic short squeeze and subsequent bout of deleveraging across key players is causing pain at an index level, we muse on what could follow.


Fresh of a series of record highs last week, the risk rally and recent reflation focus has hit pause. The week prior saw all-time highs for US indices, the small cap Russell 200, S&P 500 and the NASDAQ. In Asia, the TAIEX also reached a record high and the ASX was trading at an 11 month high prior to Friday’s risk off moves.

With the recent rally reaching overextended levels, the correction to the downside is correspondingly sharp. In today’s trade, regional indices are trading lower following the sharp plunge overnight and US futures are in the red, although recovering off lows. The ASX 200 on track for its worst session since September last year, as the risk asset complex shakes out crowded USD shorts and reflation longs providing opportunity to reload and re-establish longs in preferred stocks, sectors and geographies. Bitcoin plummeting ferociously, although if history is any guide a dip buying opportunity emerging below $30,000.

Overnight volumes were up significantly, NASDAQ up 65% vs. last 10-day average, S&P 500 up 50% vs. last 10-day average. The volumes and price action signalling an unwind/de-grossing reducing exposure on both the long and short side. Covering shorts to hold winners and vice versa, forced selling to cover losses on shorts etc. More typical of a positioning shake out and market clearing event over a trend change.

The historic short squeeze has been widely covered in the financial media and we won’t add to the noise for the purpose of today’s note. My colleague Peter Garnry has covered the key items off with some informative links in his piece, which can be found here.

The long and the short of it, hedge funds are hurting, according to Bloomberg data from Morgan Stanley’s prime brokerage show Monday and Tuesday ranked among the top five de-grossing days for its hedge fund clients over the past decade. The problem from here, whether the initial bout of deleveraging causes a chain reaction of squeezed positioning. Harking back to February 2018’s “Volmageddon” event should be ample reminder of the pain that can be felt across financial markets once a painful deleveraging process is underway. Although the panic in 2018 also coincided with an underlying macro trend change, which is not part of the current setup, hence we err on the side of this event being a positioning shake out and market-clearing event over a trend change.

Although the correction has been sharp, particularly in contrast to the recent acceleration of upside moves, it may prove to be as short as it has been sharp. In the US Q4 earnings have continued to surprise to the upside, across the broad S&P 500 earnings growth has increased sequentially 8.42%, the bottom in the earnings cycle is behind us, with the global cycle now in an early expansion. The earnings surprise vs. expectations for the 134 companies that have reported sitting at 20.55%. The upturn in the earnings cycle, in combination with the setup of growth rebounding and inflation picking up alongside epic amounts of liquidity, excess net savings and incentivised risk taking (intervention incentivising less cash on hand) is inflating asset prices. The long/short deleveraging process undertaken by hedge funds has not changed this regime. Yes, there is a great deal of speculation and many signs of excess, but given the aforementioned, we prefer to remain cautiously long of our preferred "reflation trades” as economic recoveries resume into Q1. Particularly against the backdrop of more fiscal stimulus and free flowing central bank liquidity.

Emerging markets, Asia, Commodities and bets on higher yields and higher inflation (base effects, pent up demand and supply crunches) are the place to be. Alongside a shift in market leadership toward more cyclically orientated stocks, sectors (energy, materials, miners, industrials, financials and travel and leisure stocks, small caps – IWM), and geographies (emerging markets – e.g. EWZ, EWT, THD, etc.). For more on mounting inflationary pressures and the commodity bull trend our Q1 outlook can be found here.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Saxo Capital Markets (Australia) Limited
Suite 1, Level 14, 9 Castlereagh St
Sydney NSW 2000
Australia

Contact Saxo

Select region

Australia
Australia

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Limited ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide and Product Disclosure Statement to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as CFDs and Margin FX products may result in your losses surpassing your initial deposits. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.
Please click here to view our full disclaimer.