The Big Short (squeeze)

A study of the S&P 500 futures’ net speculative position reveals that we are witnessing one of the largest futures short squeezes in history. Net shorts went from 417,000 (on 5/30/23) to 106,000 (8/15/23) while the S&P rallied as much as 20% at its 23 July peak of 4,634. Massive buybacks averaging almost $1tr. per year have more than offset the Federal Reserve’s QT and this year’s rally has been as painful to spec shorts and benchmarked investors as it has ever been.?

Now that most of the shorts have been covered, the S&P 500 will painfully miss the slow and steady bid that reduced drawdowns and depressed volatility. This may translate in higher volatility and downside vulnerability.

Speculative Positioning as a contrarian indicator of the S&P 500

An analysis of S&P 500 futures’ speculative positioning can give us hints about future (no pun intended) market behaviors. To make an apple-to-apple comparison, it was necessary to scale the data properly, taking into account the consolidation of the “big” S&P future with the E-Mini and dividing the net non-commercial position by the sum of longs and shorts. This measure of Percentage Net Futures Positioning (PNFP) is more stationary around 0% and can be a good contrarian indicator of the technical condition of the market.

2007-2009. In the period that preceded the Great Financial Crisis (GFC), the net short position of -35% was steadily reduced to the point that at the time of the October 2008 collapse, speculative positions were practically flat! To add insult to injury, spec positions switched to net long and increased throughout the entire sell-off. Longs were only reduced to zero by the time the market finally bottomed in March 2009….

2018-2020. More contrarian positioning hints can be observed in the period that preceded and followed the Covid 19 crash. In 2018, net positioning was super-long at +30% while the S&P declined 21.3%. Before the Covid sell-off positioning was flat and it became almost -30% (short) while the S&P500 rallied 31%!

Positioning as a contrarian indicator of volatility

Similar and perhaps more blatant conclusions can be reached by comparing PNFP to volatility. It took an entire year for speculative positions to go from a record short (-35.2% in September 2007) to flat in September 2008. After which the VIX exploded from 25% to 68% and 20-day historical vol exploded from 35% to 87%!

Conclusions

Market technicals can paradoxically have a stabilizing effect when economic developments defy consensus forecasts (see this year’s unanimous Recession call). Despite a 104 basis points sell-off in the 10-year US Treasury yield, since 5 April 2023, the S&P has rallied 7% and the more interest rate sensitive Nasdaq has rallied 15%. Notwithstanding the positive economic surprises and decent earnings, if history is any guide and the squeeze continues at the current pace, the steady buying that has reduced volatility and downside tails will end over the next few weeks. Then and only then, the S&P 500 and the VIX may converge towards their fundamental values.

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