However, that call volume has eroded from February’s peaks suggests some of the craze for the products is diminishing. Over the past 20 days, an average of over 23.6 million calls have traded on U.S. exchanges. While still historically high, that’s down from nearly 29 million in late February.
Credit Risk Written Off
Companies that have loaded up on debt have been rewarded mightily in the equity market. Stocks in a basket defined by their high leverage have gained over 17% year-to-date, ranking them as the best-performers this year among 17 quantitative styles tracked by Bloomberg. On the other side of the trade, profitability is one of the worst-performing factors, with those shares nursing losses of over 5%.
Goldman Sachs Group Inc. data tells a similar story: S&P 500 firms with weak balance sheets are on track to beat out those with sturdier finances by over 17 percentage points this quarter—the biggest margin of outperformance since at least 2006.
Taken together, such statistics can be used to paint a picture of a market so frothy that investors are willing to disregard any qualms over credit risk. But it’s also true that those companies—among the hardest hit by the coronavirus—stand to benefit the most from the so-called reopening trade as vaccines are given and economic activity picks up. Along with the combined might of governmental fiscal aid and the Federal Reserve’s seemingly endless bond-buying, the stock market’s weakest links can have the biggest bounce.
“These were the companies where investors were most concerned about not surviving, so they tend to get a relief rally,” said Truist’s Lerner. “Having the Fed with so much monetary stimulus and support makes investors more confident this won’t become systemic.”
High Hedge Fund Leverage
It’s not just Hwang’s Archegos that loaded up on borrowed money to make trades. Average leverage across the 10 largest hedge funds clocked in at 15.9 as of June 2020, according to data from the Treasury Department’s Office of Financial Research. While that figure is down from a peak of 24.6 in June 2019, it’s far above the 5 average for the next 40 largest funds.
That number dwarfs the amount of leverage Hwang was operating with. Market participants estimate that the family office’s total assets had grown to anywhere between $5 billion to $10 billion, while total positions may have topped $50 billion.
But while the biggest hedge funds may have more leverage than Archegos outright, it’s important to consider what those funds are leveraged to, according to Bespoke Investment Group’s George Pearkes. For example, concentrating a smaller amount of leverage to handful of stocks is much riskier than putting a bigger amount of borrowed money in instruments like Treasuries or currencies, he said.
“If an asset is less volatile, more leverage can be applied safely,” said Pearkes, a global macro strategist at the firm. “And that’s generally what’s going on with larger funds.”
—With assistance from Claire Ballentine.
This article was provided by Bloomberg News.