Market Rally Could Get a Boost From Hedge Funds Scrambling to Cover Shorts
Francesco Casarella | Feb 08, 2023 08:47AM ET
- Markets reacted positively to Jerome Powell's comments
- Soft-landing scenario appears possible now
- Hedge funds will be forced to close shorts and go long if the markets don't start dropping soon
- NASDAQ Composite +1.9%
- S&P 500 +1.29
- Dow Jones Industrial Average +0.78%.
Fed Chairman Jerome Powell's speech yesterday was highly anticipated. In particular, the markets were waiting to see what he would say following Friday's strong employment data.
To recap, non-farm payrolls came in three times higher than expected and the unemployment rate came in at 3.4%, a level not seen since the 1960s.
Here are the highlights from yesterday's speech:
Inflation is slowing, although he reiterated the need for further hikes. He said:
h2 2% Inflation a Priority/h2"The task of bringing inflation to the central bank's target is still a long way off in a tight labor market,"
"We didn't expect [January's jobs report] to be as strong as it was, but it shows why we think this process [of bringing inflation down] is going to take a significant period of time because the labor markets are extraordinarily strong."
It is positive that inflation is starting to come down and that it is not at the expense of a strong labor market. At this point, the rises the markets are expecting are at least 2 (0.25% each) to get to the 5.25% zone, and then we will see, data-driven month by month then.
With all this in mind, how did the markets react yesterday?
This was after an initial bounce, a dip, and a very strong close. Certainly, investor sentiment has changed. In 2022, they sold in the face of uncertainty. In 2023, they are buying.
U.S. options volume data is interesting and shows a significant growth in activity along with the market rally.
Now, many large investors (including hedge funds), who are still underweight or even short on equities could be on the verge of being forced to cover and go long should the market continue to rise steadily (as we shall see), adding to the rally.
In terms of fundamentals, given that the most realistic scenario is a soft landing (or even a non-recession), earnings per share should be around $225 in 2023.
We must multiply the P/E ratio in line with the market (the historical average is around 17), possibly removing (2022) or adding (2023) the effect of speculation.
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