On Wednesday, FedEx stock skyrocketed more than 12%, overshadowing the infrastructure bill impact on the market by a mile. Thin liquidity conditions were in place as hedge funds hurried to cover their short positions. The S&P 500 index followed suit with its best month of the year, climbing a whopping 9.5%. Simultaneously, a basket of the most shorted stocks significantly outperformed it, soaring a remarkable 12.5% on the day’s trading session.
The day turned out to be an unusual six sigma event for U.S. markets. So did selling, with the day’s trading volume skyrocketing to an astounding 30 billion shares, the heaviest on record, according to Nasdaq and FactSet data. As this trend threatened short sellers’ positions, an unprecedented wave of activity was unleashed. The latest Bank of America calculations showed that short positioning had almost doubled from the highs reached at the beginning of the Covid pandemic back in early 2020.
Once the trading day started, hedge fund short sellers scrambled to cover their shorts within minutes. This action played a large role in the pattern of higher stock prices through the afternoon. Goldman Sachs said Monday that stock futures that can be traded with one click dropped to an all-time low of $2 million. This sharp drop in trading volume at a time when liquidity has already been squeezed may have exacerbated the liquidity challenges that traders are facing.
Long-only funds took the baton and purchased a record level of tech stocks. This wave of buying occurred especially during the final three hours of day trading. A perfect storm of heavy buying combined with short covering set up the jump in price. This caused a wave of short sellers to rush to cover their positions.
“You can’t catch a move. When you see someone short covering, the exit doors become so small because of these crowded trades,” – Jeff Kilburg, KKM Financial CEO and CIO.
That’s why hedge funds quickly rushed to cover their shorts. This reaction was indicative of the negative impacts of the market shorting behavior that occurred during that day’s dramatic stock market rise. Goldman Sachs just released their observation on the very large spike in a basket of the most shorted stocks. This momentum development led to a rollercoaster trip for the entire market, as traders’ sentiment about future financial efficiency dramatically improved.
As Bank of America’s trading desk noted, the trend of short covering is just getting started. Their review suggested that investors are still “flying by instruments” through rough market weather, with more turbulence possibly on the way.
“The desk view is that short covering is far from over,” – Bank of America’s trading desk.
Oppenheimer’s trading desk echoed similar sentiments, noting the intense pressure short sellers have faced in recent weeks.
“The pain on the short side is palpable; the whipsaw we have witnessed the past few weeks is extreme,” – Oppenheimer’s trading desk.
Market analysts consider all of these developments as pretty unambiguous signs that a much bigger trend is underway. They foresee growing volatility as traders react to the changing market landscape. Our analysis shows that thin liquidity and record high short positioning both provide a recipe for volatility. In this type of market, unexpected price swings have the potential to rapidly change the mood of the market.