Even some of the smartest hedge fund managers have thrown in the towel. After being agnostic for most of April and May, and seeing the market grind higher and higher, they were forced to cover their shorts and go all-in by June. According to the latest CFTC speculative filings, Hedge Funds are now net long in the 99 percentile and even institutions are invested. The S&P 500 has seen its e-mini short contracts fall by 200,000 contracts as shorts were covered last few weeks. Ironically speaking, the market peaked on June 8 and has since then been trading choppily in a 150-point range. The bears have successfully regained the 3000 level twice to the downside, breaking again this morning, with the bulls desperately trying to recapture 3050 to take the market back up towards 3100 plus. What has changed?
This 38% rally has been the fastest 50-day rally in history, truly unprecedented. The Fed has broken all textbook plays and reacted in the most aggressive way possible to avoid a market collapse as its balance sheet expanded by close to $4 trillion in less than four months. After announcing that they would be buying a broad basket of Corporate Bonds, one would imagine it would be the companies whose debt needed support. Instead they reported that the basket included debt of companies like Toyota (TM) , Volkswagen (VLKAF) , Daimler (DDAIF) , AT&T (T) , Apple (AAPL) and Microsoft (MSFT) ! Some of them are debatable, but one would not be mistaken for wondering why on earth Microsoft and Apple are on the list especially given how much money they have on their balance sheets. These emergency Fed funds were to be used to help small companies or financially strapped companies out, so then why are the Technology bellwethers being bailed out with taxpayer money?
Something else changed in the last two weeks. The Fed's balance sheet is no longer expanding. We can debate whether this rally is fundamental or technical. Anyone who denies this is all manipulated and liquidity driven is naive. The market and risk assets have a 1:1 correlation with the Fed's balance sheet. The latest update showed that the Fed was still buying MBS and Treasury quotas, but had reduced the level of repo and offshore dollar swap lines, the net effect being less liquidity in the system. In just two weeks, and we have seen the S&P 500 unable to stand on its own.
Of course, the press will attach a narrative to suit the tape as it feels best. On Saturday alone, the global number of new coronavirus cases was reported at 189,000. It was obvious a few weeks ago that the number of global cases would rise as economies slowly reopen and people immerse back into society, especially without masks as many are in the U.S. This can and will delay the recovery as people will be fearful of the second wave impacting spending and travelling. All this was ignored a few weeks ago when the Fed was still adding about $50-$60 billion to their balance sheet. The macro backdrop is the same, a slow muted bounce after a strong obvious bounce post April's zero activity.
The bulls are convinced the Fed and Treasury will announce even more stimulus, with chants like "the market can never go down" echoed in the background. There is talk of $1 trillion in fiscal stimulus and extension of the CARES act. If that is the case no matter how irresponsible it can be positive for the market. It will be hard for it to pass Congress especially as U.S. debt is a concern and the market is out of the danger zone, for now. The urgency is less. What the bulls may not have factored in is that perhaps the Fed will wait till the market drops a lot more before doing more QE or announcing stimulus. After all, they can't use all their bullets at once.
For now, one of the biggest tailwinds, QE, for the market has vanished over the past few weeks. It remains to be seen how it can survive without the Fed coming out to bail each time the market drops. Over the past decade, investors are addicted to these constant liquidity doses, and know not how to invest otherwise. Now the Fed's resolve is being tested to see how soon they come back in to support it should the S&P 500 lose its key 200 day moving average support of 3020.