Hedge Funds Haven't Made a Bet This Big in 5 Years

The hedge fund world is at a multi-year extreme in betting against the 10-year note

Senior Vice President of Research
Oct 2, 2023 at 9:15 AM
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“…based on continuation moves immediately following bull and bear gaps in 2023, Thursday’s gap lower suggests selling in the immediate days ahead…With the (SPY) Sept. 29 430-strike put the last heavy (and meaningful) put open interest strike, it is possible that delta-hedging contributed to the selloff last week, but this strike could continue to act as a magnet…I think the market is vulnerable to further weakness in the week ahead, but set to recovery in early October, when any remaining delta-hedge selling is exhausted…an immediate risk is follow-through selling to the 4,190-4,225 area. The former is the site of the SPX’s 200-day moving average and the latter marks a round 10% above the 2022 close.

Monday Morning Outlook, September 25, 2023

As expected, following the Thursday, Sept. 21 gap lower in the benchmark S&P 500 Index (SPX -- 4,288.05) and its tendency in 2023 to continue in the direction of that gap, the SPX experienced another down week. It is now exactly 300 points below its late-July closing high, a decline of 6.5%. If a 10% correction is in the cards, there would be approximately 200 more points of downside to 4,130.

Potentially contributing to the decline, as I discussed last week, was the heavy quarterly expiration of put open interest (OI) at the 430-strike on the SPDR S&P 500 ETF Trust (SPY -- 427.48). This put-heavy strike may have acted as a magnet that fueled delta-hedge selling when the SPY gapped below the strike Tuesday morning.

The SPX traded as low as 82 points below the previous Friday’s close by the middle of last week. A recovery from both the Wednesday and Thursday intraday lows – after delta-hedge selling was exhausted – likely set the stage for a rebound.

Albeit another down week, it could have been worse, as stocks reacted well to inflation data on Friday morning before reversing from the highs. Last week’s SPX low was at 4,239, or only 14 points above the top end of a potential support range between 4,190 and 4,225. The latter level is 10% above the 2022 close, as I noted last week.

Despite a recovery from Wednesday and Thursday’s intraday lows and Friday` morning’s upside reaction to inflation data, the SPX’s reversal from the June closing low resulted in another losing week and a win for bears, who have been in control since late July.


Indeed, the bears are in control, with the SPX below its 50-day and 80-day moving averages that have acted as support at various times this year. Plus, it is below its June closing low and the jury is out as to how long selling will continue after the bearish gap two weeks ago.

But just as bulls are challenged with technical risks, I see bears at risk longer term for two reasons: 1) the behavior of the Cboe Market Volatility Index (VIX -- 17.52) late last week, and 2) anyone positioned for higher rates and lower stock prices is part of a crowded trade.

With respect to the VIX, which tends to rise amid market selloffs and decline amid market strength, there is the potential that last week marked a peak. Note that it failed to sustain a move above 18.23, which is half last year’s closing high. Moreover, on an intraday basis, the 19.23 level, which is 50% above the 2023 closing low carved out in September, acted as a peak. If you have followed my commentary over the years, you are aware that the VIX has a tendency to pivot at round number percentages above or below a key level, or even a round year-to-date percentage above or below the previous year’s close.

As such, the action of the VIX appears to favor the bulls, at least as it stands now. Equity buyers be aware that a move above the aforementioned levels could precede VIX readings of at least 21.67, the 2022 close, or 25.64 -- double the September closing low.


“Dimon Warns 7% Fed Rate Still Possible, Times of India Says”

Bloomberg headline, September 25, 2023

We are still early in what will become the biggest bond market crash in U.S. history. Given that the U.S. economy is more levered now then at any time in history (governments, corporations, and individuals,) the coming economic and financial crisis will be unprecedented in size.”

- Peter Schiff, Twitter, September 27, 2023

Bill Ackman Believes the 10-year Treasury Yield Could Approach 5% soon

CNBC, September 28, 2023

“Blackrock’s Fink sees 10-year Treasury Yields at 5% or higher”

Bloomberg September 29, 2023

The 2023 Stock-Market Rally Sputters in the New World of Yield

The Wall Street Journal, September 29, 2023

Per the above excerpts, we can easily gather that stocks have suffered under the weight of higher interest rates. This is exhibited with the yield on the 10-year note surging from around 4% at the late-July peak to more than 4.50% at present.

The surge in yields has caused big name Wall Street CEO’s and money/hedge fund managers to predict even higher yields. As such, we know what yields have done, but we don’t know where yields will go.

The sentiment aspect – many think yields are headed higher – has grabbed my attention from a contrarian perspective. This is because in January 2023, 60% of money managers expected yields to move higher that month. Yields on the 10-year note, however, moved lower, from 3.87% to 3.57%.

In mid-April, a J.P. Morgan survey of its clients expected lower yields on the 10-year note by year end. This nearly marked a low in the yield in 2023, as it was yielding around 3.6% at the time compared to more than 4.50% now.

If those two anecdotes do not grab your attention, consider the two charts below.

Large Speculators, which are typically hedge funds, are making extreme bets against the 10-year note. In other words, the hedge fund world is at a multi-year extreme in betting against the 10-year note. Since yields move inverse to the note, they are positioned for higher rates at an extreme level (first chart below).

The last time they made a bet of this size was exactly five years ago in September 2018. Per the second chart below, note how they were dead wrong, as yields on the 10-year note moved steadily and drastically lower the following 12 months.



Considering that many of these are bearish stocks -- they expect equities to fall under the weight of rising interest rates -- a repeat of September 2018 through September 2019's falling rates would be a major positive surprise for equity investors.

As such, I see the sentiment backdrop on bonds and stocks as a major risk to the bearish case, especially with the SPX trading above longer-term support in the 4,000 to 4,200 region.

The former is the site of a trendline breakout in January 2023 that connected major lower highs in 2022. Moreover, the SPX’s 12-month, 24-month and 36-month moving averages are currently situated between 4,150 and 4,200.

The SPX’s 36-month moving average is at 4,175 and has generally been supportive of the index on a monthly closing basis since its cross-over in 2010.

While this may be convincing for taking both a bullish stance on bonds and stocks, patience is recommended, as being too early can have devastating results. For example, while “everyone” is bearish bonds, yields remain above “resistance” since October 2022 at 4.30%. As such, the crowd is being rewarded so far and extremes in sentiment can become bigger extremes.

You want to time your moves when you think the consensus outlook is crumbling and/or not as “clear cut.” Price action can help guide you, such as yields falling back below 4.30% and/or equities trading back above a key level, whether that be the June closing low at 4,330 or the pre-gap close of 4,400.  

But even at these levels, there is not much upside to other potential resistance levels, such as the 80-day moving average, currently sitting at 4,440 and also the area of the June highs.

This interaction of multiple short-term resistance levels overhead but long-term support not far below -- and an extremely bearish sentiment backdrop on both bonds and stocks -- might suggest a choppy, sloppy, volatile range into the year's end.


Todd Salamone is the Senior V.P. of Research at Schaeffer's Investment Research.

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