Biggest Ever Bear-Market Bounces Create Unending Pain for Shorts

(Bloomberg) — A disaster for bulls, the yearlong tumble in American stocks has in some respects been almost as rough for the other side of the trade.

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The hardships of being short were made vivid Tuesday as a Goldman Sachs Group Inc. basket of most-hated stocks climbed more than 4%, saddling bears with losses. While the S&P 500 have alternated between gains and losses into 2023, each up day overpowered the previous down session, resulting in an overall gain that marked the market’s best start to a year since 2019.

Such a bounce, landing right after hedge funds spent December raising bearish positions and retail traders dumped stocks in droves, has been a prescription for pain playing out over the past 12 months. Skeptics had their conviction tested by bear-market rallies on a scale almost without precedents. While the S&P 500 saw far fewer up days than is normal in 2022, when the index did manage to rebound, it did so violently. Rising a median 1.15%, the index’s increase on positive sessions was the largest since 1938.

“There’s a FOMO element here with investors who are worried about being caught offsides if equities embark on a durable rally,” said Adam Phillips, managing director of portfolio strategy at EP Wealth Advisors. “Everyone knows bear market rallies are common, but it can be hard for some to remember that in the moment.”

Up days were as big as they were rare. The S&P 500 spent 43% of last year’s sessions in the green — trailing all but one year since 1941. By contrast, down days piled up, befitting a year when the benchmark swooned 19.4%. But skeptics have had to cope with counter-trend advances repeatedly.

While up and down days have been evenly split into the new year, the S&P 500 rose 1.3% on average on the three positive sessions, more than double the size of its move when it fell. Up about 2%, the index’s return was the third-best so far into a year during the past decade.

Read more: Equities Take the Escalator Down and the Elevator Up: Macro Man

The latest recovery came right after hedge fund clients tracked by JPMorgan Chase & Co. cut their average leverage to the lowest level since 2017. Meanwhile, individual traders dumped more than $3 billion of shares in the week through last Tuesday, the third-biggest selling in the history of JPMorgan’s market-wide data.

Rising ahead of the market this week have been tech stocks and the Nasdaq 100 advanced for three straight sessions, the longest winning streak in two months.

The revival in tech leadership, if continued, is likely unwelcome news for those who have avoided the industry after the once-lauded stocks fell to the Earth in 2022. At the end of December, hedge funds tracked by Morgan Stanley saw their tech exposure sinking to a three-year low.

Underpinning the new year’s equity bounce was a drop in bond yields and weakening dollar, according to Mark Freeman, chief investment officer at Socorro Asset Management LP. With earnings sentiment souring, he said, bears may look for opportunities to pounce again despite near-term challenges.

“There are still some significant headwinds facing the markets, mainly what happens on the earnings front, but at the margin the bears are facing a tougher fight,” he said. “Obviously short covering magnifies the up moves but the shorts then just reset at a higher level and downside pressure resumes.”