Leverage, as measured by NYSE Margin Debt data, was up 31.6% on the year in January and 10.2% on the month to $364 billion, approaching the July 2007 peak of $381 billion.
Excessive cash draw-down has led to a contrarian sell signal, according to the latest Hedge Fund Monitor from Bank of America Merrill Lynch.
Net free credits (essentially, cash levels in margin accounts) were at a negative $77.2 million for January, according to BofAML analyst Mary Ann Bartels.
“Leverage can be used as a sentiment indicator because it is related to investor confidence. It tends to be correlated to the direction of the equity market—investors are likely to gain confidence and add leverage when the equity market is going up and vice versa,” said Bartels.
“Current readings indicate that investors are becoming more confident in the equity market, which generally supports further upside. Just short term levels have gotten a bit ahead of themselves with cash levels now drawn down to levels which typically result in market correction.”
Against this backdrop, hedge funds continued to underperform the S&P 500. The investable hedge fund composite index was up 0.33% for February as of February 27, compared to a price return of 1.19% for the S&P 500.
Convertible arbitrage funds were the best performers for the month, adding 1.23%. CTA advisors were the worst, losing 0.55% for the same period.
Bartels said their models indicate market neutral funds bought market exposure to 1% net long from 4% net short while equity long/short funds held market exposure steady at 33% net long, just below the 35-40% benchmark. Macros aggressively bought the S&P 500, NASDAQ 100 and10-year Treasuries; sold commodities; and added to their shorts in U.S. dollars. They also added to their EM and EAFE shorts.
Data from the Commodity Futures Trading Commission showed large speculators sold NASDAQ 100 futures, were flat the S&P 500 and bought the Russell 2000.
Large agriculture speculators bought soybean, sold corn and added to their shorts in wheat while metals speculators bought gold, sold silver and copper, slightly sold platinum and were flat palladium. Energy specs sold crude oil, heating oil and gasoline but remained flat natural gas.
Forex speculators sold the euro, bought the dollar and were essentially flat the yen. Interest rate specs aggressively bought 10- and 2-year Treasuries while remaining essentially flat 30-year Treasuries.