On Tuesday, Barclays (LON:BARC) presented a new analytical tool named the ’Equity Euphoria Indicator’ (EEI) designed to measure the intensity of investor sentiment in the stock market. This announcement coincides with recent observations of significant changes in market positions and investment strategies among various types of funds following the US presidential election.
According to Barclays, long-only equity exposure has increased notably since the election, while hedge funds still appear to have the capacity to enhance their positions. This trend is particularly evident in global macro and multi-strategy hedge funds, which have shown limited activity in re-grossing their investments. Despite a sell-off in the bond market, bond funds have not shown signs of a large-scale exit.
In the wake of the election, the US dollar has strengthened, leading speculative investors to amplify their short positions in other global currencies, reflecting a growing belief in US economic outperformance.
Systematic funds, which include Volatility Control, Commodity Trading Advisors (CTAs), and Risk Parity funds, have recently reduced their long positions in equities, aligning their allocations closer to historical averages. Volatility Control funds have the potential to increase their equity exposure, but any inflows are expected to be incremental, given the volatility anticipated with the implementation of President Trump’s policies.
CTAs have notably taken a large short position in the Russell 2000 index, while maintaining a relatively higher position in the NASDAQ index. With rising rates and volatility in the bond market due to inflation concerns, CTAs have also established significant short positions in bonds, and Risk Parity funds have similarly decreased their allocations.
The strong US dollar post-election has led to CTAs taking extended long positions on the currency, particularly against the euro. However, recent benign inflation data has created conditions that could lead to a partial reversal of these extended positions in bonds and the EUR/USD currency pair.
The EEI aims to provide insights into the underlying dynamics of the stock market by analyzing derivatives flows, including volatility technicals and option flows. Despite recent downturns in the equity market, the EEI indicates a level of investor optimism not seen since the dot-com bubble of the early 2000s, suggesting that investors should proceed with caution.
Current equity positions are largely filled, prompting investors to protect against downside risks while showing skepticism towards significant upside potential. This is reflected in the options market, where there is evidence of increased buying of downside protection and selling of upside potential.
Notably, institutional investors, rather than retail investors, have been the primary drivers of call overwriting flow, with the supply of gamma from buy-write funds remaining at historically significant levels. Additionally, the positive intra-day auto-correlation signals that dealers are short in this environment.
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