(Bloomberg) – An ominous thought for stock market stalwarts: You won’t have the bears to beat anymore.
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Fresh off the strongest first half of the S&P 500 in five years, the eradication of unbelievers has shown signs of accelerating. A source of anxious buying when the tide turned, short sellers who arrived in 2023 preparing to feast pulled back from their positions as stocks rallied.
A change in sentiment can be seen in data showing that bearish positions in exchange-traded funds have slipped to their lowest level in three years, while short positions in S&P 500 futures have been unwound at the pace the fastest since 2020. Meanwhile, the population of optimists is exploding, with bullish writers in the Investors Intelligence survey topping bears by 3 to 1, the highest level since late 2022.
It’s an axiom of investing that one of the best setups a long trader can hope for is one where everyone is prepared for disaster. Such was the situation as doubts about the economy surfaced in 2022, and it helps explain how well the bulls have fared since markets bottomed nine months ago.
Today, the strength of the rebound puts pressure on the bears, leaving the market with one less accelerator as worries about the Federal Reserve’s war on inflation reassert themselves at a time when corporate earnings are expected to fall. for a third consecutive quarter.
“Sentiment isn’t extreme but it is strained, and recent surveys suggest it won’t provide the same tailwind to equities going forward,” said Adam Phillips, managing director of portfolio strategy at EP. Wealth Advisors. “As we look to the second half, we expect the market to be tested as investors demand results to justify recent performance.”
Stocks fell in the holiday-shortened week as strong data in the labor market and services activity rekindled fears that the Fed will continue to raise rates to tame inflation. Treasury yields hit new highs. All major equity benchmarks were in the red, with the S&P 500 slipping 1.2%.
Short sellers likely lost $37 billion in June, according to an estimate from analytics provider Ortex. Losses have piled up for the bears all year as artificial intelligence-driven optimism propels the tech giants, lifting the S&P 500 to double-digit returns that defied the pessimists.
Signs are mounting that skeptics, willingly or not, are retreating after initial resistance. Big speculators, mostly hedge funds that saw their net short positions on the S&P 500 hit a record high in late May, were busy unwinding their bets over the next four weeks. Their bearish holdings fell by 226,000 contracts during the period, the biggest drop since mid-2020, according to Commodity Futures Trading Commission data compiled by Bloomberg.
Among newsletter writers tracked by Investors Intelligence, those classified as bulls rose to 54.9% while the proportion of bears fell to 18.3%. This is in stark contrast to the end of last year, when the bears overtook the bulls.
The rapid shift in sentiment has even Ed Yardeni, one of the early proponents of this bull run, wondering if there are too many optimists.
“Elevated bullish sentiment can be a signal of caution,” said the chairman of Yardeni Research, whose bold call in January for a sustained rally in stocks proved prescient.
In ETFs, short-term interest is near a three-year low based on its percentage of market value, according to Markit data compiled by Morgan Stanley’s sales and trading team. Short-term interest in individual businesses – without completely dissipating – has fallen back to mid-levels across most industries.
Count rules-based fund managers among those who have been pushed to buy stocks as the market rises. Systematic funds, including those that perform asset allocation based on price momentum and volatility signals, were net buyers of $40 billion to $45 billion of global equities in June, the team estimated. Morgan Stanley, noting that their purchases since January marked the second fastest on record. any six month period.
As it stands, the quantitative cohort’s equity exposure has increased to the highest level since February 2020, hovering around the 80th percentile over the past five years.
“This translates into greater fragility for any continued requests for group actions,” the Christopher Metli-led team wrote in a note. If their exposure were to return to the historical median, it would drive stock selloffs of up to $160 billion, they estimated.
For now, equity pullbacks remain shallow, in part because traders await more economic and earnings data to get a better picture of the fundamental outlook. The S&P 500 has gone without a 2% weekly decline for 17 straight weeks — the longest streak of resilience in nearly two years.
Big banks are set to kick off earnings season next week and analysts expect a 9% contraction in second-quarter earnings for S&P 500 companies, according to data compiled by Bloomberg Intelligence.
If we rely on the positioning of investors, the lack of confidence in the economy persists. As active funds have continued gains in the AI-fueled tech rally this year, they have reduced their exposure to economically sensitive companies like energy, analysis from Bank of America Corp showed. In fact, the group’s cyclical exposure to defensive exposure is near all-time lows, according to company strategists led by Savita Subramanian.
The continued aversion to cyclical stocks reflects the view that an economic recession is delayed, but not completely averted, said Matt Frame, partner at Bornite Capital Management, a stock-picking hedge fund.
“At the index level, we’ve gone from deeply bearish sentiment in the fall to the other extreme right now, particularly in tech. I don’t think it’s fair to say that this is true for all sectors,” he said. “It’s really a story of two markets with technology and the overall market re-evaluating higher year-to-date, while Cyclical stocks fell around the recession theme. You need to see some participation outside of technology if stocks are going to continue to rise. »
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