Ten days ago we shared some very relevant insight by JPM’s Marko Kolanovic on the future of the S&P500, who succinctly explained how the broader market is “trapped” as a result of the US Dollar, which is too strong for a specific set of S&P500 constituent assets and not strong enough for another core set. To wit:
S&P 500 and USD: we are not excited about owning the S&P 500 as core exposure to risky assets. The S&P 500 is capitalization weighted, has high momentum bias, is internet heavy, and is implicitly long USD (when the USD is near historical highs). The current correlation of the S&P 500 to USD is ~30%. One of the reasons behind the positive correlation of the S&P 500 to USD is the high weight in Momentum and Low Volatility stocks in the index, and these stocks’ positive correlation to USD. At the same time, the index has low weight in Value stocks that are negatively correlated to USD (correlation of momentum, value and S&P 500 to USD are shown in Figure 1). When it comes to macro drivers of equities, the S&P 500 may be trapped by USD: it can’t rally to new highs without USD (momentum sectors, FANGs, etc.), and at the same time the strong USD is capping any significant upside due to its negative impact on EPS (via value segments such as multinationals and energy).
What this means is that before one can form a definitive view on the future direction of the S&P500, aside from BTFD “just because”, one first has to decide what the USD will do from here.
And that’s where we run into a problem, because according to the latest Commitment of Traders data, the outlook of the “smart” money managers has never diverged as much as it does right now.
As BofA’s Athanasios Vamvakidis writes, the USD found support from month-end corporate demand and increasing official sector buying, but hedge funds also continue their tentative USD buying for the third week. The contrast to the CFTC data which showed another week of strong USD selling could be due to the reporting lag for CFTC, which is through Tuesday, whereas our flow captures the positive tone to the US data at the end of last week. Real money USD selling also looks to have been concentrated towards the beginning of the week, so a continued shift in sentiment from real money this week, would imply a more USD positive backdrop, from relatively light positioning (Chart 1). US data this week will be key.
Whatever the reason, as the chart below shows, as of this moment, Hedge Funds are now the most bullish on the dollar they have been in the past year, while “real money” is the most bearish.
For those unsure, here is the difference between the two categories as per BofA:
- Real Money: Pension Funds, REITs, Small Institutions/Trusts, Insurance, Asset Management and Finance Companies. RM clients will often trade FX to facilitate transactions in Fixed Income or Equities rather than to take a view on FX itself.
- Hedge Funds: Usually limited-partnership funds with diverse, often leveraged strategies designed to maximize returns. HF flow is speculative in nature, and many HF trade FX as an asset class
By definition, one of these two groups is very wrong on the future direction of not only the USD but also the market. While we look forward to finding out just whose investors will end up footing the bill for their manager’s incorrect macro assessment, one thing is certain: the HFT algos will win.
via Zero Hedge http://ift.tt/1LPVlGu Tyler Durden