Technically Speaking: Hedge Funds Ramp Up Exposure

 | Jul 20, 2021 05:35PM ET

The “Fear Of Missing Out” has infected retail and hedge funds alike as they ramp up exposure to chase performance.

We have previously discussed the near “mania” of retail investors taking on exceptional risk in various manners. From increasing leverage, engaging in speculative options trading, and taking out personal loans to invest; it’s all evidence of overconfident investors.

it all comes down to the “psychology” of QE:

“The key to navigating Quantitative Easing! and Fed policy in general is to recognize that their effect on the stock market relies almost entirely on speculative investor psychology. See, as long as investors get inclined to speculate, they treat zero-interest money as an inferior asset, and they will chase any asset with a yield above zero (or a past record of positive returns). Valuation doesn’t matter because investors psychologically rule out the possibility of price declines in the first place.” – John Hussman

In other words, “Quantitative Easing” is a mental formation. Therefore, the only thing that alters the effectiveness of the Fed’s monetary policy is investor psychology itself.

Such was a point we made in the

“With the entirety of the financial ecosystem now more heavily levered than ever, due to the Fed’s profligate measures of suppressing interest rates and flooding the system with excessive levels of liquidity, the ‘instability of stability’ is now the most significant risk.”

Given professional managers are subject to “career risk,” they get forced to “chase performance.”

h2 Hedge Funds Are All In/h2

Hedge fund managers are now extremely long “risk” exposure.

Wall Street Journal :

“Client notes from both Morgan Stanley (NYSE:MS) and Goldman Sachs (NYSE:GS) show fundamental stock-picking manager had negative alpha in the first half of the year.

Part of the challenge for professional stock pickers is that markets are heavily rotational. Markets this year whipped back and forth between growth and value stocks. Such makes it difficult for managers to find winning trades.”

Sentiment Trader had an excellent piece of data to this point:

“The latest estimate of Hedge Fund Exposure shows that funds are nearly 40% net long stocks, a quick rise from almost being flat a month ago. Over the past few years, after such large allocation increases, the S&P 500 gave any further gains back.”

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“After any day since 2003 when Exposure was below zero, the S&P 500 returned an annualized 15.2%, versus only 1.4% when Exposure was above 25% as it is now. If we look at the period after the first reading above 35% the medium-term returns were unimpressive.“ – Sentiment Trader

The point is that when professionals investors get “sucked” into performance chasing, it warrants being more “risk” aware.

As Bob Farrell once quipped:

“Investors tend to buy the most at the top, and the least at the bottom.”

h3 Smart Vs Dumb Money/h3

None of this should be of any surprise. After more than a decade of monetary interventions, the psychology of QE is now thoroughly ingrained. The problem eventually is that with investors very “long” the market, there will be few “buyers” when it comes time to sell.

As discussed in “There Is No Way, This Doesn’t End Badly,” virtually every measure of fundamental analysis suggests the markets are expensive.

“10-year forward returns are below zero historically when the price-to-sales ratio is at 2x. There has never been a previous period with the ratio climbing to near 3x.”