It’s a crowded trade.
That’s one concept that my friend Peter Tchir of TF Market Advisors (http://www.tfmkts.com/ ) uses to assess the potential risk and reward of a strategy. In concept it’s pretty simple: Look to see how much of the market, how much of the available money, is already lined up on one end of a trade or the other. And ask, how much more money is available to further push up an already popular trade or what it would take to get money to flow into the currently unpopular end of a trade. (The concept is simple. Where Peter and his partner Jeremy Hill excel is in figuring out how to measure how crowded a trade might be.
Looking at the markets right now I’d have to say being long U.S. equities is a very crowded trade.
As of September 27, Markit Securities reports that only 2.4% of the shares in the companies on the Standard & Poor’s 500 are out on loan to short sellers. That’s near a record low.
Granted that number may have changed in the days leading up to an actual government shutdown, but given the performance of the market in the last few days, I don’t think short interest has climbed significantly. (To go short, after all, you borrow shares and then sell them, and I don’t see a wave of selling recently.)
Markit’s data shows an equally crowded long trade on European equities with short positions on European shares totalling just $144 billion, the lowest level since Markit began tracking this data in 2006. (For more data on this see http://www.markit.com/en/about/news/commentary/commentary-article.page?dcr=/en/securities-finance/2013/27-09 )
This crowded trade doesn’t mean that U.S. and European stocks have to go down. The bet right now, which sees the shutdown of the U.S. government as a minor road bump, is on third quarter earnings. For the last five quarters, stocks have climbed on the day that the company has announced its earnings,” according to Bespoke Investment Group. That’s the longest streak in at least a decade according to Bespoke’s data
But it does suggest that the upside to this trade is limited by the popularity of the trade and that the downside is relatively large if either the budget/debt ceiling battle is more serious than expected or if earnings in the third quarter, which begin with Alcoa (AA) on Tuesday, October 8, disappoint.