Hedge funds are betting stocks will fall

Hedge funds and large speculators are betting 2023′s market gains are unsustainable. Bearish bets, as evidenced by Commodity Futures Trading Commission (CFTC) data, have hit levels unseen since late 2011.

That sounds ominous, but such pessimism is potentially bullish for stocks. When positioning gets lopsided, unexpectedly good news – for example, positive economic data or strong earnings – could result in a short squeeze, with bearish traders scrambling to get out of losing bets.

Historical data lends support to this idea; 2011 was a year of great turmoil for stocks, but bad news was priced in by the end of the year, setting the scene for 2012′s strong gains. Speculators were also heavily short near market bottoms in 2015 and 2020. Meanwhile, CFTC data suggests everyone was bullish in late 2018 and late 2021, when markets were about to tumble.

Of course, it doesn’t always turn out this way. Sometimes, everyone is bearish for good reasons. Short bets hit extremely high levels in September 2007. Soon after, stocks tanked as the global financial crisis got under way. Will the shorts also be right on this occasion? Perhaps, but contrarians will be hoping another short squeeze fuels the next leg up in markets.