(Bloomberg) -- For the second time in two weeks, bragging rights belong to rally skeptics who have been crowding into trades designed to pay off when the stock market stumbles.
First it was the $2 trillion lost in a near 6% stock swoon nine days ago. Now Wednesday’s, which reached 3% at its worst point. Both drops were big enough to rank in the top 15 of the five years before the Covid crisis happened.
The sharp drops are a reminder that a quick economic recovery and containment of the coronavirus aren’t certainties. That’s been the central thesis of bears who have taken every chance, and pointed to every negative statistic, to throw cold water on the historic stock rebound. At least today, hedge funds who shunned the rally and investors who loaded up on protection looked smart.
“For anyone who’s hedged, it’s definitely paying off now,” Matt Maley, chief market strategist for Miller Tabak, said by phone. “It doesn’t have to be the kind of full-scale, large-scale lockdown to throw a wrench in the works of a V-shaped recovery and especially a recovery in earnings.”
On one level, it’s not news that people owning what amounts to insurance against market declines should get a big payday in a session like Wednesday’s. Of more significance is just the size of bets massing in these areas, a sign that deep skepticism still exists toward a rally that has added around $10 trillion to share prices since March.
The latest CFTC data, for example, showed hedge funds and other large speculators took their net positions against the S&P 500 to the highest since early 2016. In other words, as the rally ran higher, these investors pressed their bets even further that a turnaround was in the offing.
Evidence has also highlighted hedge funds embracing safer stay-at-home stocks while shunning the recovery trade that retail investors have grown to love. That choice hurt performance in the first week of June, when a Goldman Sachs basket of stocks beloved by retail beat a group of hedge fund favorites by 14 percentage points. Since then, the advantage has turned, with the hedge fund holdings set to beat the retail basket for a third week straight.
In recent days, investors have also rushed to exchange-traded funds that hedge against stock losses or a rise in volatility. The iPath Series B S&P 500 VIX Short-Term Futures exchange-traded notes (ticker VXX), for example, took in $274 million at the start of the week, its largest single-day inflow since March 19. That paid off Wednesday, as the fund jumped as much as 11%.
Also, after the recent shuttering of other ETNs, including the $1.5 billion VelocityShares Daily 2x VIX Short-Term ETN (TVIX), VXX will be the “only game in town”, according to Eric Balchunas, an analyst at Bloomberg Intelligence.
“Ten years later and VXX continues to be one of the most popular ways to hedge a selloff given its ability to go into jackpot mode, but it largely just burns cash so you have to nail the timing,” said Balchunas. “It’s also likely picking up some TVIX refugees who crave the VIX juice.”
The ProShares Short Russell 2000 ETF (ticker RWM) -- a fund that seeks to deliver the inverse performance of the small-cap gauge -- has also grown more popular. Investors have poured $295 million into the fund since April’s start, the most for any quarter on record.
That security rose as much as 4.7% Wednesday as small-caps took a hit. Still, the Russell 2000 is up 21% this quarter, on track for the index’s best since 2003.
“It’s possible that people who were more bearish felt very foolish as the market jumped ahead over 40%,” said Jonathan Golub, Credit Suisse’s chief U.S. equity strategist. “But you can have the market easily come back 10% or 15% as we get clarity that this is not going to be a perfectly smooth escape toward a normal economy.”
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