Quants Forced to Shed $225 Billion of Short Bets in Big Squeeze

(Bloomberg) — Fast-money quants were effectively forced to buy an estimated $225 billion of stocks and bonds over just two trading sessions, as one of Wall Street’s hottest strategies in the great 2022 bear market shows signs of cracking.

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As cooling consumer price data sparked a cross-asset rally, trend-following traders were compelled to unwind short positions totaling about $150 billion in equities and $75 billion in fixed income on Thursday and Friday, JPMorgan Chase & Co. strategist Nikolaos Panigirtzoglou estimated.

Given their notable firepower, Wall Street strategists are now touting the potential for further sharp market gains — if these systematic managers such as Commodity Trading Advisors find themselves under pressure to hike their exposures anew.

CTAs, which take long and short positions in the futures marketplace, may purchase $28 billion worth of stocks this week if benchmarks close largely unchanged, according to an estimate from Scott Rubner, Goldman Sachs Group Inc.’s managing director. Should bonds stand still, that could lead to $40 billion of purchases over the next week — and potentially $100 billion in the next month, his model tracking various markets suggests.

The projections signal an ongoing allocation shift among the rules-based cohort, who have netted historic gains by riding the inflation trade earlier this year, with bearish bets against shares and Treasuries combined with bullish exposures to the dollar and commodities.

“Most CTA AUM momentum is now positive and demand from this community is going to explode,” Rubner wrote in a note to clients Friday.

Stocks oscillated between gains and losses Monday, with the S&P 500 starting the day in the red before rising as much as 0.4%. The index then dipped again in afternoon trading to close the session 0.9% lower.

Getting a grip on the exact picture of the quant world is far from easy. Models built on subjective assumptions often spit out different numbers. A similar analysis by Nomura Securities International’s cross-asset strategist Charlie McElligott, for instance, showed that the systematic cohort bought a more modest $61.4 billion of stocks and $2 billion of bonds last week.

Still, the analysis helps shed light on the fierce rally, one that many say was an over-reaction to the softer-than-expected reading in October’s consumer price index. At a minimum, the exercise illustrates the importance of tracking technical indicators such as fund positioning at a time when the fundamental picture remains murky.

Up almost 6% last week, the S&P 500 has taken out some key trendlines, including its average prices over past 50 and 100 days. According to Goldman, CTAs likely stepped up purchases when the index recaptured the 3,804 level — which flashed positive short-term momentum signals — and 3,966, seen as a threshold of momentum over the medium term.

If the sudden bounce endures, it will be a challenge to an industry that has thrived in a year where hot inflation and the Federal Reserve’s campaign to tame it became the anchoring force for asset performance.

An index by Societe Generale SA tracking CTAs slipped for a sixth straight session through Friday. Down 5.2% over the stretch, the industry just suffered its worst bout of performance since March 2020.

Kathryn Kaminski, chief research strategist and portfolio manager at AlphaSimplex Group, said it’s too early to call an end to the great inflation trade. The firm’s AlphaSimplex Managed Futures Strategy Fund (ticker ASFYX), which slipped almost 5% last week, is still up more than 38% this year.

“The short-term relief trade looks counter to the past trend, but when we consider the longer term outlook there is still evidence based on Fed commentary this weekend and the overall level of inflation that this trend will not be over so quickly,” Kaminski said in an interview. “In simple terms, some of the key issues still remain and rates may still need to go higher to get to a more stable level of inflation.”

Despite the buying binge, CTAs are far from being risk-on. Currently, the industry is neutral on equities and short on bonds, according to estimates from Deutsche Bank AG.

“There is potential for them to add to both equity and bond positions as exposure to both is quite low,” Parag Thatte, a strategist at Deutsche Bank, said in an interview. But it “relies on their volatility continuing to go down and for the market to stay flat or up.”

To JPMorgan’s Panigirtzoglou, the risk for the group is another market reversal.

“Now that their shorts are largely covered, the bleeding would stop and they could start making profit if the recovery continues and start building up long positions,” Panigirtzoglou said in an interview. “The worse scenario for them is reversals, i.e. to start building up long positions over the coming weeks and then whipsawed by a market reversal.”