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Torrid stock rally springs from exhaustion among institutions

It’s a contrarian view, premised on logic that floors are found when sellers get exhausted, that gained adherents this week as the S&P 500 staged its biggest rally in two years just as the Federal Reserve threatened to raise interest rates as many as 10 times through 2023.

March 19, 2022 / 11:06 PM IST
Representative image

Representative image

Gloom had been overflowing among institutional investors when it came to American equities. That might have been just what the market needed.

It’s a contrarian view, premised on logic that floors are found when sellers get exhausted, that gained adherents this week as the S&P 500 staged its biggest rally in two years just as the Federal Reserve threatened to raise interest rates as many as 10 times through 2023.

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The five-day bounce of 6.2% was a ray of light for those hoping a two-month selling binge by professional speculators has been severe enough to account for all the bad news weighing on investor psyches of late. Stock pickers, computer-driven traders and hedge funds have been unwinding positions at one of the fastest paces in years, overwhelming retail buyers whose bid kept markets aloft in 2020 and 2021.

“I just think there’s not that many sellers left,” Jim Paulsen, chief investment strategist at Leuthold Group, said by phone. “That’s often how a bottom happens. It’s not so much that buyers come. It’s that selling quits.”

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Through Monday, the S&P 500 had fallen in 9 of the 11 sessions, pushing it down 13% from its Jan. 3 record. Notably, that streak ended on the same day a survey by Bank of America found surging skepticism among global money managers toward equities. They reported raising cash to the highest levels since April 2020 amid broad expectations that a bear market for equities is inescapable.

The S&P 500 rallied nearly 7% the next four days to notch its best week since November 2020. The tech-heavy Nasdaq 100’s four-day surge topped 10%, giving it an 8.4% gain in the week. The VIX volatility gauge closed below 25 for the first time since mid-February.

“We had priced in a lot of the Fed action as of even the decline that we saw in the U.S. markets in January, so the equity market was well-prepared for what the Fed said,” Bloomberg Intelligence’s Gina Martin Adams said on Bloomberg TV. “We’ve literally priced in more than anticipated before any tightening cycle we’ve seen since the 1970s.”

Institutional selling has been a feature of U.S. stocks since the start of the year. Macro systemic strategists, including volatility-targeting funds and trend-following commodity-trading advisers, dumped $200 billion of global equities in the first two months of 2022, according to data compiled by Morgan Stanley’s trading desk.

Hedge funds slashed their equity exposure to the lowest level in almost two years in February and have since kept trimming into the new month, according to data compiled by Goldman Sachs Group Inc.’s prime brokerage. Their net leverage fell 7.5 percentage points over the two weeks through March 11, the largest decrease over any comparable period since at least January 2016, Goldman data show.

JPMorgan Chase & Co. strategist Marko Kolanovic observed a similar trend among the fast-money cohort. Exposure for volatility sensitive investors, including hedge funds and risk-parity portfolios, has fallen into the bottom 10th percentile of a historic range. Such light positioning is one reason that Kolanovic urged investors to take advantage of the latest selloff to boost risky wagers.

“Current risk positioning is very light. This is a result of high and persistent volatility, and risk aversion caused by global geopolitical developments,” Kolanovic wrote in a note Thursday. “And for this reason, risks are skewed to the upside.”

There were signs all the de-risking left fund managers ready to pounce. Net buying by Goldman’s hedge fund clients during Tuesday and Wednesday, for instance, was the 12th largest over any comparable period in the past decade.

Leuthold’s Paulsen said that in March 2020, when the market took off after a 35% fall, it wasn’t because buyers stepped in. It was because the selling had been spent -- and something similar is unfolding now, particularly within the institutional community.

A number of banks have lowered their S&P 500 year-end targets, which “reflects that they’re all hunkered down for bad times, which is a contrarian signal,” said Paulsen. “They’re not going to sell any more because they’re waiting for the market to fall further, because they’re now positioned for that.” And if stocks keep going up, those players will feel pressure to wade back in.

Aside from positioning, bulls got a boost from some macro developments. China stepped in to arrest a plunge in its stock market, sparking a furious rally after it signaled it would ease a crackdown on tech firms. While fighting continued in Ukraine, several headlines suggested talks had made some progress.

Retail investors have been undeterred throughout the early year selling, conditioned by years of buying dips and having it pay off. Individual investors have purchased a net $39 billion of stocks since January, the largest at this point in at least five years, according to data compiled JPMorgan Chase & Co. strategist Peng Cheng.

Overall, though, at-home traders’ participation has decreased to 17% of overall volume, down from roughly 24% a year ago, according to an analysis by Jackson Gutenplan and Larry Tabb at Bloomberg Intelligence. The amount of shares changing hands has reached a record, triggering a high in the average share-price traded, meaning that the market is being swayed by institutional-investor heft.

“Institutional traders, major money managers, asset managers and hedge funds, their moves have to do with the current market conditions -- a lot of volatility, a lot of uncertainty, inflation concerns, geopolitical concerns,” said Gutenplan in an interview. “As the market continues to downtrend, institutions selling out of positions are overwhelming any retail buying pressure.”

The data depict a market where war in Europe and reinvigorated central-bank hawks have snapped professional investors back into action after two years of retail ascendancy.

Retail traders have had a “fantastic” run since the pandemic broke out, said Ryan Nauman, market strategist at Zephyr. But, “even though retail has gained a lot of momentum over the past two years, institutional money still outweighs the retail money, and it’s still going to move markets.”

Shawn Cruz, senior market strategist at TD Ameritrade Inc., looks at a retail-investor sentiment measure tracked by his firm called the Investor Movement Index (IMX). Clients have been cutting their exposure to stocks though they’re still buying, Cruz says -- they’re just being a lot more selective. Many are selling out of highly valued technology firms and are moving into “not-going-anywhere-anytime soon” companies instead.

“There’s a little bit of what I think is a retrenchment going on, where they weren’t just buying everything across the board,” Cruz said by phone. “As much as there is some pulling back, and there’s a lot of volatility going on, you’re seeing some selling in the more highly valued areas and the buying is very targeted.”

Others see retail’s involvement as potentially pointing to a bottoming process, as well. Liz Young, head of investment strategy at SoFi, says mom-and-pop investors tend to follow institutional trends, meaning that the at-home-trader cohort might soon “join that outflow party.”

“That’s where you get more confirmation of, OK, the bearishness is taking hold,” she said in a Bloomberg Radio interview. “Maybe you get to an extreme bearishness, and that’s usually where you bottom out.”
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