You could agree with JP Morgan’s July 13 note that stocks have gone to new all-time highs because: (1) they are not quite as ridiculously expensive as bonds; (2) corporate earnings are about to roar higher after four straight quarters of declines; and (3) investors are taking more risk, rotating out of safe haven stocks into underperforming cyclicals and financials, tech hardware, semis, materials, autos and airlines. Or you could wise up and smell the coffee.
Stocks are on a roll because central banks are doing a post-Brexit money-printing watusi world-wide and that’s panicked the many large short sellers into a short-squeeze of biblical proportions.
Below is the chart of three-month rolling average asset purchases (the black line) by the four largest hedge funds central banks plus the central banks of Emerging Markets. The black line has accelerated to almost vertical.
Now, below is a chart comparing the relative performance of the S&Ps (green line) versus the stocks with the biggest short positions (red line). Note the divergence beginning in early July as the short sellers began to cover their positions in the most-shorted names.
This is a massive short-squeeze, up over 15% in 10 days.
The Most Shorted stocks are at their highest since November, 2015.
A short covering rally must be the answer because investors are pulling money out of equity funds (at last check for 17 consecutive weeks) at a pace that suggests a flight to safety. The chart below shows record U.S. equity fund outflows in the first half of this year, the fastest pace of withdrawals for the first half of the year on record, despite a fast-rising market and fresh central bank money.
This rally is not to be trusted. In my opinion, you should not buy into it. With investors headed the other way, it can’t last long.