Professional speculators are sticking to their long-held cautious stance even after the latest equity rally forced them to unwind short trades at one of the fastest paces in years.
Hedge funds that make both bullish and bearish bets have largely avoided adding fresh long positions, despite a second straight monthly advance in the S&P 500 Index, data from Wall Street’s major prime brokers show.
Fund clients tracked by JPMorgan Chase & Co. have reduced wagers in both their long and short books, reversing all the risky exposures that they had taken on between late August and the end of September. At Goldman Sachs Group Inc., hedge funds saw their combined trading flow falling for a fifth straight week. It’s a sign of tepid risk appetite that suggests the smart money reckon the recent equity bounce is nothing but a bear-market trap.
The propensity to hold onto defensive positioning may ultimately set the stage for a rally into year end, as seen in market rebounds earlier in 2022. At the same time, it reflects prevailing concerns that the 11-month bear market has yet to run its course. Echoing warnings from strategists from Goldman Sachs and Morgan Stanley, separate surveys from 22V Research and Renaissance Macro Research showed the majority of their clients view this bounce as likely short-lived.
With trading poised to slow into the holiday season, just one investment mistake might undermine a manager’s performance for the year, a career risk that many are trying to avoid.
“We’re approaching year-end and there is often some de-grossing that happens as liquidity dries up,” JPMorgan’s team including John Schlegel wrote in a note last week. “Thus, hedge funds might not be willing to add much risk in this environment.”
Across the board, hedge funds’ equity exposure remains subdued. As of Thursday, net leverage, a measure of the industry’s risk appetite, sat in the second percentile of a range since 2017, JPMorgan data show. A similar picture showed up among Morgan Stanley’s clients, where net leverage stood in the 22nd percentile of a one-year range.
The industry is known for its persistent precaution this year, a posture that has helped money managers fare relatively better during the rate-spurred market crash. Right now, however, skepticism appears to be widely shared.
In the poll conducted by RenMac Monday during their client calls, 88% of the respondents said stocks are in a bear-market bounce. A separate survey conducted by 22V last week showed only 5% of investors considered this year’s serious retrenchment as being over.
It’s not hard to see why the consensus view stays bleak. While soft inflation readings of late gave investors hopes that the Federal Reserve may ease its pace of rate hikes, events in December -- from the central bank’s policy meeting to data on consumer prices and the labor market -- have the potential to upend any optimism.
And while stocks have suffered massive valuation corrections, they are no screaming bargains -- especially if profit estimates for 2023 keep falling. At the market’s low in October, the S&P 500 was traded at 17.3 times earnings. That’s the highest multiple among all 11 bear-market troughs since the 1950s, data compiled by Bloomberg show.
After jumping about 10% since mid-October, the index’s price-earnings ratio has expanded to 19. The multiple has yet to reflect a potential earnings drop next year, according to Venu Krishna, head of US equity strategy at Barclays Plc. His team expects the S&P 500 will end 2023 at 3,675, a 7% decline from the latest close.
“Current multiples are baking in a sharp moderation in inflation and ultimately a soft landing, which we continue to believe is a low probability event,” Krishna wrote in a note Monday. “Though we’re likely past the inflation peak, it doesn’t mean we’re past the equity market trough.”
This article was provided by Bloomberg News.