Updated June 26, 2023

The Smart Money Is Positioning for a Credit Crunch

The broad equity indices had modest pullbacks last week (on the order of 1.5%-2%). But given the intensity of the recent runup, those pullbacks barely registered. 

Someone tweeted that the Nasdaq 100 just had its third best 30-day performance since 1984. 

Bank of America noted the Nasdaq’s rolling 3-month Sharpe ratio touched 7 this past week. 

And the S&P hadn’t had a weekly loss more than 80 bps since the week of March 10. 

Thus, a 2% pullback on a 36% YTD return (for the Nasdaq 100) is a mere papercut.

But next week is a new week and things are starting to get interesting under the hood. 

As Goldman Sachs flow strategist, Scott Rubner, put it:

“Bottom Line: Sentiment is no longer bearish – it is greedy. Investors are no longer short – they are long. Retail traders are back, liquidity is currently robust heading into the summer, pension rebalancing, corporate repurchase blackout, change the flow-of-funds picture. It will be harder from here. Those investors who will be stopped into the market have been stopped in already at this point.”

On the positioning front, the big news from last week was that the smart money in the dollar used the dollar selloff from the prior week to buy the dip in size. Dollar relative sentiment is now a hair’s breadth away from turning bullish. While it’s possible it could turn back down (without turning bullish), that seems unlikely.

If dollar relative sentiment were to turn bullish (and we expect it will), that would almost certainly have non-trivial effects on a wide range of assets–just as its turning bearish in mid-October helped jumpstart the equity rally from the October lows. 

Perhaps corroborating the smart money’s buying of the dollar, institutions again sold equities last week, dropping their equity-positioning z-score further into negative territory at -0.25. Markets don’t seem to put in meaningful tops, however, until that z-score is at or beyond -2. So, there’s still some ground to cover in that regard.

Indeed, other measures of equity relative sentiment indicate equities could have up to five more weeks of supportive positioning. Which again suggests a market top is not imminent. 

Notably, the Nasdaq continues to have the most supportive relative sentiment positioning both on a standalone basis and relative to the S&P 500 (and Russell 2000). Thus, its year-to-date outperformance, as extreme as it has been, may persist. 

Positioning in gold has firmed up a bit and is now in a state that has been modestly supportive of gold in the past. Thus, we may see gold (which fell 2% last week as the dollar climbed 0.7%) attempt a rebound in the (potentially small) window of time before dollar relative sentiment turns bullish. 

Last week, we mentioned that energy and commodities–which have struggled–may be on the verge of seeing a market rotation given the shunning of energy stocks and the U.S.’s need to refill the Strategic Petroleum Reserve. 

Yet, the relative sentiment relationships that drive energy and commodities are giving no indication a rotation may be near. Thus, we may continue to see sideways or lower churn in those markets until investor positioning becomes more favorable. 

Tying those all together, we have: bearish positioning in energy and commodities, soon-to-be bullish positioning in the dollar, a firming in gold’s positioning, and institutions selling equities.

Is the market suggesting a second-half credit crunch? 

The Bull Case

The bull case for equities is narrow, but not necessarily weak. It rests on the market’s current technical strength and the residual effects of prior positioning and earlier breadth thrusts. Societe Generale also argues there is room for P/E expansion if the AI boom trades similarly to the dotcom boom (though the other side of that expansion might not be pleasant). 

The Bear Case

The bear case for equities is gaining steam. We have:

  • Stretched (although not extreme) positioning

  • Potential end-of-month pension-fund rebalancing between equities and bonds given the large outperformance of equities 

  • Contracting bank lending, Fed liquidity rolling over, junk bond defaults soaring

  • A meme stock frenzy—recent trading volume in meme stocks is in the 99th percentile of the last five years (according to Goldman Sachs)

  • 85% of corporations will be in the blackout window for stock buybacks by the end of this week (thus removing that bid from the market)

  • The aforementioned changes in investor positioning across the dollar, equities, gold, and commodities

Our View

Things are starting to get interesting. For what seemed like an eternity, institutions were stubbornly bullish while speculators and retail investors were stubbornly bearish. Now that’s no longer the case. 

Institutions are selling equities (to retail and speculators) and the smart money is buying the dollar. So, it’s reasonable to believe that at some point in the not-too-distant future we will get a change in trend. 

Whether that change in trend comes several weeks from now (perhaps after a blowoff top in the market) or more immediately with a continuation of last week’s pullback is more difficult to ascertain. 

Whereas institutions tend to be more timely with their buying when it comes to calling market bottoms, when it comes to timing the top with their selling, they often sell too early and the market continues to drift higher.

We tend to come down on the side that the market will continue higher (even if we get a near-term pullback) and we may even get a blowoff top, primarily because:

  • Several of the mega-cap tech stocks appear to have unfinished business on the upside (gaps to close, technical patterns to fulfill, etc.)

  • Investor positioning in equities likely won’t turn bearish until the end of July

  • Across all equity indices, sectors, regions, and countries, the Nasdaq 100 has the most bullish relative sentiment configuration of all

  • Animal spirits are revved up and the lack of any material pullback (so far) only serves to foment those spirits

So far, this rally is adhering to the age-old playbook: Institutions bought equities when the narrative was uniformly bearish (H2 2022) and are now selling equities when the narrative has become almost uniformly bullish. 

Institutions likely have more selling to do before equities peak, but the fact they are selling suggests we may be closer to a top than a bottom–in either time or price or both. 

Allio Portfolio Updates

No changes to Allio’s portfolio last week. We will continue to evaluate tactical opportunities and incorporate the aforementioned evidence of a potential credit crunch into our strategic forecasts.

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