Yesterday we finally got a bounce in the equity markets. But what was most interesting was that the hedge fund rout continued, with many crowded hedge fund trades continuing to show signs of a stressful unwinding.
According to Goldman Sachs, yesterday was the worst day in terms of relative performance for the hedge funds’ long positions versus their short positions in quite some time:
Our HF VIP basket underperforms the SPX by over 100bps, 3 standard dev move and the worst since June 2012.
And the stress was not just limited to individual stock names. Many other trades that have been popular with hedge funds also exhibited strange behaviour.
The Japanese Yen short has been a popular trade with the hedge fund community ever since Prime Minister Abe pledged to stop the decades long deflationary vicious circle. Since the introduction of the aggressive monetary easing, the Yen’s weakness has also been highly correlated to the US stock market. Have a look at this chart that shows the Yen versus the S&P 500 during the past year:
USDJPY (white line) vs S&P 500 (yellow line)</a> </div>
You will notice that a higher USDJPY rate (lower Yen) has corresponded to a higher US stock market – almost tick for tick.
Although the relationship between the two asset classes does shift around, on a day to day basis, the general trend of both is almost always in sync.
Therefore it was highly unusual to see the USDJPY have a big down day (higher Yen) and for the US stock market to have the exact opposite move higher. Yet this is exactly what happened yesterday. Then S&P 500 was up fairly strongly, but the USDJPY rate went straight down (higher Yen):
Same chart -timeframe 2 days only</a> </div>
What does this mean? I think that yesterday gave us clues on a couple of fronts.
Firstly, I think the hedge funds are no longer net long the stock market. In fact, I think they have quickly shifted camps and have pushed their luck to the downside. I think that is why we went up yesterday. The very fast money has overplayed their hand on the short side and was forced to cover.
Secondly, I believe that we are seeing signs of the hedge funds losing their patience with Japan. The short Yen trade is a crowded trade. Over the last year, it has also been a big winner for the hedgies, but their patience with Japan is slowly being worn thin.
The break down of the Yen/Stock relationship was just another symptom of the dangers of trading on the same side as the hedge funds. When they exit (or are forced to exit) many of these relationships actually reverse during their unwind.
This sort of breakdown is why the hedge funds are having such a bad month. All of their trades are turning against them at the same time.
Yesterday I took the opportunity created from the hedge fund mad scramble for the exits to re-establish my Yen short at 102. I will add to it in the low 101s if the Yen strength continues.
USDJPY chart (lower rate = higher Yen)</a> </div>
I am aware of all the bad news emanating out of Japan regarding their lack of aggression regarding more QE. But I think the hedge funds are getting shaken off this trade during this period of portfolio stress and that it will prove a mistake. The long direction for the Yen is down (higher USDJPY).
I can kiss my career as a political analyst goodbye
A couple of weeks ago I highlighted the popularity that the Parti Quebecois was experiencing in the polls. I argued that the market was not ready for a PQ victory and that if they were to somehow win, the CAD would get hammered.
I guess the reason that the market was “not ready” for the PQ victory was because it knew that their chances were quite slim. The PQ completely blew their lead, and not only failed to win, but got completely trounced by the Liberals.
In hindsight the addition of Karl Peledeau to the PQ lineup was a complete disaster. He brought attention to the fact that at its heart, the PQ party is a separatist party. And the Quebec people have almost zero appetite to go down that road again.
I am running out of time this morning, but I think that the CAD is another short trade that has a potential for a squeeze as the hedge funds continue to unwind their more aggressive trades. A Liberal victory in Quebec takes one of the potential negative CAD surprises off the table.