After Massive Rally Post-March Lows, Major Equity Indices Falling Under Their Own Weight

The recent selloff in equities has come at a time of elevated Fed balance sheet, stabilizing earnings estimates and improving macro data. Either stocks believe these positives are not lasting or they are falling under their own weight, as they rallied massively from March lows. Several indicators have a ways to go before their overbought conditions are unwound.

Market squeezes go both ways. In a long squeeze, a decline in price is perpetuated by panic selling by longs. In a short squeeze, shorts are forced to cover, providing further boost to the price. Nowhere was the latter more obvious than e-mini S&P 500 futures the past several months.

After a February-March collapse, the S&P 500 large cap index (3340.97) bottomed on March 23 at 2191.86. By September 2, it tagged 3588.11. The nearly 64 percent surge came in a little less than five and a half months. When the rally got underway, investor mood was somber, with several indicators at washout levels.

Nevertheless, non-commercials, who were net long e-mini futures until the week to March 24, switched to net short in the following week and stayed bearish until last week, for a total of 23 weeks. Throughout this, the S&P 500 ripped higher. (SPX)

Seven sessions ago, the index reversed after rising to the aforementioned record high. Last week, non-commercials switched to net long (Chart 1). (Their holdings are as of last Tuesday.) In essence, what this could mean is that the short-squeeze fuel that provided such a strong tailwind to the rally is spent up. Now, bulls will have to do the heavy lifting themselves.

On the NYSE, a similar phenomenon is in play. By the middle of March, short interest stood at a four-year high 17.9 billion shares. As stocks rallied, shorts began to turn tail. By the end of August, short interest had dropped to 14.2 billion – a 75-month low (Chart 2). Once again, zealous shorts lent a big helping hand to the 53.5 percent rally in the index. (NYA)

That said, these dynamics are a little different on the Nasdaq. At the end of June, short interest stood at 9.5 billion, which was the highest since mid-September 2008. The index was just getting ready for another leg higher. Shorts beat a hasty retreat. In the next month and a half, short interest declined 4.2 percent to 9.1 billion. In the next period – that is, by the end of August – shorts again got active, raising short interest to 9.4 billion, which is not that far away from the end-June high. They have been rewarded this time. The Nasdaq peaked on September 2 and is down just a tad over 10 percent.

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