After Massive Rally Off March Lows And Options Waiving Caution Flag, Johnny-Come-Latelies Risk Holding The Bag

Cash is piling up on the sidelines. As of last Wednesday, money-market funds stood at $4.79 trillion, yet another record and up $1.4 billion from the prior week. On a four-week moving average basis, these assets were $4.77 trillion last week, up $34.4 billion week-over-week. The thing is, the w/w buildup is in deceleration (Chart 2). This is what equity bulls are counting on – reversal of the parabolic two-and-a-half-month rise in these assets. Should things evolve this way, what if equities get their fair share?

Will non-commercials afford to stay short?

As of Tuesday last week they had racked up massive net shorts in e-mini S&P 500 futures – 252,863 contracts, slightly less than 265,608 three weeks ago, which was the highest since October 2015 (Chart 3). Back then, these traders were net short 278,179 contracts, before cutting back. The S&P 500 rallied eight-plus percent in October 2015. Non-commercials obviously got squeezed. Similar squeezes occurred in October 2011 and in September/October 2007. On both those occasions, net shorts were higher than the current levels – particularly in September 2007 when they amassed 408,653 contracts.

So, the question is if non-commercials start covering now or from a higher level. Timing notwithstanding, once this process begins, it can feed on itself. Bulls obviously hope this begins sooner.

They are also salivating over Nasdaq short interest. By the middle of March, this had built up to 9.36 billion shares, which was the highest since end-September 2015. After a 24-session, 32.6-percent collapse, the index bottomed on March 23, as did other major equity indices. Short interest dropped 7.6 percent in the second half that month, to 8.65 billion. Shorts either locked in profit or decided it was time to cover sensing a decent bottom. Since then, short interest has inched up, but nothing major. That said, historically, the red bars in Chart 4 remain elevated. 

The mid-May count is due out this Wednesday and should be interesting. The Nasdaq rose 1.4 percent in the first half this month. The question is if a decline in short interest played any role in this.

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