The S&P 500 climbed 2.9% on Oct. 10 and 11 to 1,703.20, fewer than 25 points from its record on Sept. 18. Companies with the most short sales rose 3.5% in the two days and erased all losses since the U.S. government shutdown began Oct. 1, data from Bloomberg and Goldman Sachs show.
The ISI index of hedge fund long versus short bets fell to 48.4 in the week ending Oct. 9, from a 2013 high of 52.5 in March, data from the New York-based research firm show. Its lowest point this year was 48.2 in August. As ISI’s index decreases, it indicates managers are growing more bearish on equities. The measure dropped 4% in the last three weeks.
“As of Wednesday, hedge funds had turned cautious on the market amid the federal government shutdown and approaching debt ceiling,” Oscar Sloterbeck, senior managing director at ISI, said in an e-mail on Oct. 11. “While positioning does not appear extreme historically, the survey suggests there is buying power for equities if a deal is reached in Washington.”
The HFRI Equity Hedge Fund Index advanced 9.2% in the first nine months of 2013 and is poised to trail the S&P 500 for a fourth year, according to data compiled by Bloomberg. The gauge has gained about 48% since the rally started in March 2009, compared with 111% for the S&P 500. Hedge funds were closer to the S&P 500 during the last bull market, rising 85% from October 2002 through October 2007 as the S&P 500 jumped 90%.
The rally in 2013 has been the broadest in at least 23 years, as the Federal Reserve committed to unprecedented economic stimulus and stock valuations remained below historic averages. Of S&P 500 members, 445 are up so far in 2013, data compiled by Bloomberg show. The next-closest year was 1997, when 436 companies had advanced and the index was quadrupling.
Short ratios tracked by ISI are about the same as they were in August 2011, the last time the U.S. was threatened with a credit default due to a budgetary impasse in Congress. Bearish bets kept rising as the debate wore on and the S&P 500 slid almost 20% between May and October of that year. The benchmark gauge for U.S. equity has since rebounded 55%.
The measure of market exposure fell to a 2 1/2-year low of 42 on Nov. 23, 2011. The S&P 500 rallied 17% the following three months. ISI’s index, based on a survey of 36 mostly U.S. hedge funds with about $89 billion under management, tracks net exposure on a zero through 100 scale. Readings of zero show “maximum” short selling.
While hedge funds were squeezed the past four years after making bearish bets before the S&P 500 rallied, this time may prove profitable because growth prospects are lower and valuations are higher.
“The rising tide will no longer lift all boats,” said Peter Rup, the chief investment officer at New York-based Artemis Wealth Advisors LLC, which invests in hedge funds. “The really good equity long/short managers will outperform.”