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  4. Hedge funds are the most bearish they've been since 2011, and that could set the stock market up for a massive short squeeze

Hedge funds are the most bearish they've been since 2011, and that could set the stock market up for a massive short squeeze

Matthew Fox   

Hedge funds are the most bearish they've been since 2011, and that could set the stock market up for a massive short squeeze
  • Hedge funds have their biggest short position on the stock market since 2011, according to CFTC data.
  • The massive short bet comes amid concerns of a potential recession and decline in corporate earnings.
  • "Bullish macroeconomic or earnings reports could trigger a short squeeze," said Ned Davis Research.

Hedge funds have built their biggest collective short position against the stock market since 2011, according to recent data from the Commodities Futures Trading Commission.

There is a net short of -321,000 contracts on the E-Mini S&P 500 futures held by "Large Speculators," which is typically viewed as being hedge funds.

The bearish positioning could be a hedge against growing concerns of a recession, the potential for an imminent decline in corporate earnings, or simply that equity valuations appear stretched after a strong year-to-date rally despite the ongoing macroeconomic and geopolitical concerns.

But while there's plenty that could go wrong in the economy and markets, there's also the potential for a positive surprise, and that could spark a short-squeeze among the bearish hedge funds that would be forced to quickly unwind their short exposure.

"This data along with the leveraged futures positioning having reached the most negative levels since 2018 could make the market ripe for a short squeeze potentially," Fundstrat's Mark Newton said in a recent note, pointing to Wednesday's CPI data as a potential catalyst.

And the bearish positioning could ultimately provide a buffer for downside potential in stock prices in the near-term, according to Newton.

"I continue to feel that negative sentiment likely will help provide a cushion to any equity decline into the back half of the month of May which is when a few cycles show more convincing intermediate-term bottoms in the cycle composite," he said.

Ned Davis Research offered a similar take on the hedge fund short data, noting that sentiment indicators like this often offer the best buy signal when they hit extremes and then reverse. So far, while the sentiment indicator has hit an extreme, it has yet to show signs of reversing.

"Like any other sentiment indicator, net futures positioning's strongest message should come when it hits an extreme and reverses. Bullish macroeconomic or earnings reports could trigger a short squeeze. The lack of open interest could make it difficult for them to cover, if others do not increase their position sizes again," NDR said in a Wednesday note.

The catalyst to a potential short-squeeze, or bust, could come in a matter of days as publicly traded companies prepare for the release of their first-quarter earnings results, with mega-cap banks JPMorgan and Wells Fargo scheduled to kick-off earnings season this Friday.


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