Source: Zhitong Finance and Economics
Author: Zhuang Lijia

At a time of banking turmoil, there is a question of concern: how does the benchmark stock index remain stable at a time when bond markets have experienced their worst volatility in nearly 40 years? Part of the answer usually lies in the position. From$SVB Financial (SIVB.US)$In the day before the sharp fall in share prices, although the collapse of regional banks has wiped nearly 1/4 off the market value of the industry,$S&P 500 index (.SPX.US)$It's down only 1%.$NASDAQ 100 Index (.NDX.US)$It has risen nearly 3 per cent over the same period and has risen 15 per cent so far this year.

This is a vivid example of resilience, especially when compared with the case of US debt. While expectations that the Fed will suspend raising interest rates are also working, hedge funds have been wary of the worst, cutting their equity exposure and increasing protection through cash and options hedging.

According to JPMorgan Chase & Co's prime brokerage department, the hedge fund's net flow to the US stock market has turned negative since August last year. The net leverage ratio of equity long-short funds, including elsewhere, is now at its sixth percentage point since 2017, a clear sign of risk aversion. In addition, according to market-wide regulatory documents compiled by Goldman Sachs Group, positions in bank stocks held by hedge funds are 343 basis points lower than those shown by the benchmark index in early 2023.

The JPMorgan team, including John Schlegel, said in a report on Friday: "this resilience may be at least partly due to the sell-off and some low positions that took place before last week." "looking at the overall situation in the US, there are many signs that capital flows are in a fairly low-risk state, especially on an one-month basis."

This calm contrasts sharply with the turmoil in fixed-income markets. Bond traders have lowered their expectations of a Fed rate hike as regulators step in to guarantee depositors at banks such as Silicon Valley banks, as they expect banks' lending standards to tighten and plunge the economy into recession. Bears betting on higher policy rates were forced to close their positions, leading to the biggest three-day fall in two-year Treasury yields since 1987.

Deutsche Bank strategist Parag Thatte and others say the different allocation of fixed-income investors and equity investors mainly explains why government bonds are more responsive to banking turmoil. Equity allocations from hedge funds to individual investors and mutual funds show a defensive posture, with indicators at 18 per cent of the historical range, according to the bank. At the same time, bond exposure hovered near its lowest level in more than a decade, making bears vulnerable to a risk-averse rebound as traders bought bonds as a haven for a possible recession.

"supported by recent data and speeches from Fed officials, bonds have been extremely short and one-sided bets until last week," Parag Thatte said on Friday. The impact of the banking sector subsequently triggered massive short covering. "

Although US stocks are more likely to rebound sharply when they rise in 2022-in part because the allocation of defensive funds makes missing gains a major concern for fund managers-that did not happen this month.

Even with low bank exposure, the hedge funds tracked by Goldman Sachs Group did not take risks in financial stocks. When the bad news piled up, they quickly pressed the sell button. Last Tuesday, when Moody's Corporation Investor Services downgraded its outlook for Bank of America Corporation's system to negative, its customers stepped up their bearish bets on banks, with the long-to-short ratio falling the most on record and hitting an all-time low.

While fleeing bank stocks, they have increased their holdings in technology stocks, which are seen as high-quality and strong balance sheets. In other words, some of the money is not completely withdrawn from the stock market, but to other parts of the market. This type of cycle helped the S & P 500 survive the banking crisis.

From options traders to stock pickers, there was a general sense of caution among equity investors before the banking crisis. Bank of America Corporation's February survey of fund managers showed that cash holdings remained at more than 5 per cent, with a net 31 per cent of respondents saying they had reduced their holdings of stocks.

In the derivatives market, just before the banking crisis worsened, traders were ready to fall further. Bullish open positions betting on a rise in the Chicago Board options Exchange volatility index (VIX), which usually equates to betting on stock losses, rose to the second highest level since April 2019. "A large part of this comes from investors actually using options to express a pessimistic view of the market," Alex Kosoglyadov, managing director of equity derivatives at Nomura, said last week.

All this pessimism means that any bad news will not come as a surprise. In fact, given the increase in short selling by hedge funds over the past four weeks, JPMorgan Chase & Co's John Schlegel and his colleagues believe there may be more upside in the stock market. "given that large-scale short selling in similar periods coincides with recent market lows, there may be another risk of an upside reversal," they said. "

Edit / Jeffrey