EHLS: Speculative Traders Skewing Markets

Difficulties in Shorting

In This Update

• Speculative Trading Surge: July saw a dramatic rise in speculative trading, complicating the management of the short portfolio, though the fund avoided being short any "meme" stocks that saw their fame re-emerge in headlines.

• Historic Short Squeeze: Goldman Sachs reported a 60% rally in shorted stocks, one of the sharpest short squeezes in history only comparable to 1999 and 2021.

• AI Theme Resumes: Meta, Nvidia, and other AI-driven stocks hit new highs, reinforcing optimism for AI's potential but highlighting the possibility of market excesses.

• Sector Performance: Mixed sector results, with Energy, Real Estate, and Healthcare remaining at the back, while Industrials, Basic Materials, and Utilities showed strength.

• Exposure Strategy: Fund maintains 50-55% net equity exposure, adapting to market fluctuations while broadening gross exposures to help manage volatility and dampen "momentum crash" risks.

Looking Back

July's market movements were anything but typical, with extreme short-term fluctuations presenting challenges for the majority of the month. As we previously noted, the market's appetite for speculative positions expanded significantly in July, complicating our short portfolio, which was increasingly difficult to navigate. The re-emergence of "meme" stocks grabbed headlines, but fortunately, our fund was not short any of these names. However, the broader trend of stocks that had been beaten down being bid up was evident, causing the short portfolio to meaningfully drag on this month’s return, with exception to the last day of the month. Goldman Sachs highlighted this recent anomaly:

“The recent rise in speculative trading activity has accompanied one of the sharpest short squeezes on record. Since early April, the GS Most Short basket has rallied by over 60%, outperforming the equal-weight S&P 500 by roughly 40%. Over the last 30 years, concentrated shorts have only seen sharper rallies in 1999-2000 and 2020-2021, periods when speculative trading activity exceeded current levels.”

Internally, while our systems don't show the same excesses as in 2021, several stocks in the short portfolio surged without clear catalysts, seeing short bursts of upside, suggesting the potential of a broader market rebalancing. To mitigate the risk of "momentum crashes," an anomaly specific to the momentum factor which can impact both the long and short sides of the portfolio, we implemented refined clustering methodologies in March and April. Since then, we've monitored gross exposures, expanding the portfolio with select tax-related redemptions and tightening gross exposure bands within clusters, which we continue to execute on.

Fidelity Research noted this year’s movement as the fastest drop and recovery in history. As highlighted in our December and January updates, sectors like quantum computing, space technology, and crypto were gaining investor interest, prior to the momentum crash observed in late February. We now find ourselves in a market favoring high-risk or beaten-down positions, specifically last month. Internationally, stocks are being bid up to levels not seen in decades. One noteworthy point, many stocks in the packaged foods, healthcare plans, and household product industries have been in near free fall this year, which are historically viewed as safe havens.

The AI-driven trade has fully re-emerged, accelerated by Meta Platforms (META) earning’s release at the end of the month, sending the stock 12% higher and adding $200 billion in market cap. Stocks like Nvidia (NVDA) and Broadcom (AVGO) reached new highs, which we discussed last month, as well as engineering firms like Sterling Infrastructure (STRL) and electrical component businesses like Celestica (CLS)—all held in the fund. While the large investments from tech firms as a catalyst for these names are not surprising, we remain optimistic about AI’s transformative potential, despite skepticism from some market observers. With META’s announcement, it is hard not to begin to see levels of excess, which we find comfort in having a system to help guide us through what could unfold as more market hysteria at some point.

Looking Forward

Sector performance shows Energy, Real Estate, and Healthcare at the back of the pack, with modest additions to the space primarily coming from a portfolio diversification perspective as we broaden gross exposures, which we intend to strategically continue executing this month. Financials, however, remain in the lead, although beginning to see slight declines internally, making way for Utilities to potentially take the lead yet again. We expect both sectors to maintain high net exposures in the fund for August despite some challenges in July.

Industrials, driven by the AI-theme and aerospace names, and Basic Materials, driven by gold and precious metal miners, have seen strength, and the fund has been increasing net exposures. This shift in miners is due to the lack of underperforming securities to short. Utilities saw renewed strength at the end of the month, which is concentrated in niche areas like Vistra Energy (VST) and speculative players like Oklo (OKLO) as well as previously mentioned international holdings like Korea Electric Power Corp (KEP). The sector slid from its April highs, but with strength seen last week, we intend to continue holding exposure in previous names mentioned as well as NRG Energy (NRG) and Entergy Corp (ETR).

We are currently maintaining a median net equity exposure around 50-55%, expecting fluctuations based on market movements. While "momentum crashes" are a normal anomaly, the current environment is far from typical in terms of the speed and magnitude of market moves. We plan to continue to broaden clustering gross exposures in the following months as it makes sense with the intention to reduce volatility at the cost of anticipated elevated turnover, particularly as we position the portfolio toward higher-ranking securities.

In April, we saw speculation dominate, and July amplified that trend to an extreme. Long-term trends remain unclear as the market continues to digest its next move, but that trend now seems to be forming back again to the upside, which we intend to try and capture. Additionally, the last week of the month is seeming to confirm the AI-trade may be back in full swing, which led the markets through 2023 and 2024, before seeing a dramatic gyration through the first half of this year. We’ll continue to monitor these movements and tactfully gain additional exposure to the theme while keeping diversification in mind.

This update expresses the views of the author(s) as of the date indicated and such views are subject to change without notice. Even Herd has no duty or obligation to update the information contained herein. Further, no representation has been made, and it should not be assumed, that past investment performance is an indication of future results. Moreover, wherever there is the potential for profit there is also the possibility of loss. This information is being made available for educational purposes only and should not be used for any other purpose. The information contained herein does not constitute and should not be construed as an offering of advisory services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Even Herd believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Even Herd made attempts to show sources and links to that data, when possible. However, Even Herd cannot guarantee or be held liable when accessing those links, as it is not the property of or maintained by the author(s). This update, including the information contained herein, may not be copied, reproduced, republished, or posted in whole or in part, in any form without the prior written consent of Even Herd.