Gavekal Capital: Commercial Traders No Longer Tailwind For Higher Stock Prices

Tuesday, September 9, 2014

Commercial Traders No Longer Tailwind For Higher Stock Prices

Each week, the Commodity Futures Trading Commission (CFTC) releases information on the long and short positions of traders in a report known as the Commitments of Traders. Groups are identified and determined by the number of contracts they are currently holding. Commercial hedgers are involved in the day-to-day operations of financial assets.  Large speculators consists of large pooled funds, and almost always take the opposite side of commercial traders. 

Generally as equity prices rise, commercial hedgers take on a greater short position, and when price fall they take on a greater long position.  When the position of commercial traders is significantly short, it suggests a large short position has been built up.  If commercial traders are short and get their directional bets wrong, it providess fuel for the market to propel higher as commercial traders have to cover their shorts by buying stock.  In turn, if commercial traders have closed out their short positions, this suggests there may be little fuel left for the upside in stocks.

If we add up the total USD of equity future contracts we can get a sense of the magnitude of the commercial hedgers’ position.  In the chart below, we take the cumulative value of all contracts on the E-mini S&P 400, E-mini S&P 500, Russell 2000, Dow Jones Industrial Average and NASDAQ 100.  In May of 2013, commercial hedgers had amassed a $55 billion short position in the spectrum of equity future contracts.  Since then, they have closed (or been squeezed) out of most of their shorts.  As of last Friday, the total short position of commercial hedgers’ stood at $3.8 billion.  In other words, commercial traders have covered some $51 billion of short exposure over the last 15 months.  This short covering induced buying has helped the equity markets attain all-time highs.  But, now the short covering has largely been completed and will no longer provide much of a tailwind for stocks.