A remarkable surge in the S&P 500 index, which has recorded a nearly 12% gain in just five weeks, may be at risk due to the potential exhaustion of trend-following funds that have been driving global stocks higher. This concern was raised by Goldman Sachs Group analyst, Scott Rubner.
Rubner, a managing director and strategist at Goldman Sachs, cautioned investors that systematic funds, also known as CTAs or commodity trading advisers, could offload over $200 billion in exposure to global stocks if the market experiences a pullback from its recent highs.
CTAs typically engage in trading equity index futures, Treasury futures, and futures tied to currencies and commodities like crude oil.
In a report reviewed early this Tuesday, Rubner stated, "The flow-of-funds dynamics that caused the everything rally in November have absolutely run out of gas right now."
During November, CTAs substantially increased their exposure to global stocks at an unprecedented pace, according to Rubner and his colleagues at Goldman Sachs.
Additionally, CTAs have purchased $225 billion worth of stocks over the past month, resulting in a net long position of $92 billion, as disclosed by Rubner. Given their already elevated exposure, Goldman Sachs anticipates that these funds only have the capacity to add another $58 billion if prices continue to rise.
However, if prices begin to decline, trend-following CTAs may reflexively shed approximately $200 billion in exposure, potentially exacerbating the market downturn.
Analyzing US markets specifically reveals a comparable pattern, as CTAs' long exposure surged back towards yearly highs in November. The chart below depicts the reversal from a net short position of approximately $50 billion to a net long position of over $40 billion.
Overall, with the trend-following funds potentially running out of steam, the ongoing rally in the S&P 500 should be approached with caution as the market faces the prospect of a correction.
Tracking CTA Flows: Insights from Investment Banks
Investment banks, including Goldman and UBS Group, have been closely monitoring the positioning flows of Commodity Trading Advisors (CTAs). The surge in CTA flows has become a topic of discussion among analysts.
Projecting Market Trends
Using fund-flows data, analysts at Rubner's firm accurately predicted a late-summer selloff in stocks. Furthermore, they anticipated that trend-followers would drive stock prices higher in April, following the recovery from the Silicon Valley Bank collapse.
A Mix of Hits and Misses
While Rubner's short-term calls have been largely successful, not every prediction has yielded positive results. In late April, he believed that trend-followers had exhausted their ability to influence the market. However, stocks continued to climb until July, reaching a closing high of 4,588.96 on the S&P 500.
Time for Portfolio Protection
Despite the recent market rally, Rubner advises traders to consider portfolio protection against a potential selloff. Fortunately, equity options that offer protection over the next three months are currently priced attractively. Other analysts share similar sentiments and recommend buying hedges at favorable prices.
On Tuesday, U.S. stocks experienced a slight dip in their opening. The S&P 500, Dow Jones Industrial Average, and Nasdaq Composite declined on Monday, while the small-cap Russell 2000 continued its climb upwards.
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