Reuters / Richard Drew
- The US equity market has dropped 5% over the past six trading sessions, and large speculators are flashing a signal that could mean more weakness.
- Hedge funds and other large investors are the most net short on 2-year Treasurys than at any point in history, meaning they see yields rising, which could challenge stocks.
Some of the market’s most influential investors are making an unprecedented bet that near-term bond yields will climb — and that could continue heaping pressure upon stock traders.
Hedge funds and other large speculators are holding a net-short position on 2-year Treasurys that’s the biggest on record, according to US Commodity Futures Trading Commission data. That implies a historical degree of bullishness on short-term yields.
Business Insider / Andy Kiersz, data from Bloomberg
This stretched positioning comes at a time when stocks are stuck in their roughest spell in recent memory. The benchmark S&P 500 has dropped 5% over the past six trading sessions, while the Dow Jones industrial average recently suffered its biggest percentage decline since Brexit.
Wall Street experts — including but not limited to Bank of America Merrill Lynch chief investment strategist Michael Hartnett — have warned against the potentially negative effect of higher bond yields. Hartnett in particular has cited the 3% level on the 10-year Treasury as a breaking point of sort for stocks.
With that in mind, the fact that hedge funds have gotten so bullish on near-term bond yields is bad news for the stock market for a number of reasons. First, if yields increase as expected, that would weaken the relative appeal of stocks, which are already trading at some of their loftiest valuations ever.
Secondly, the value of future corporate earnings declines as interest rates go up. And since the Fed is expected to hike rates multiple times this year, this dynamic could also be weighing on market sentiment.
Lastly, the higher financing costs being signaled by bullish positioning on near-term Treasurys could slow economic growth. That, in turn, could eventually be a drag on stocks, which perform best during periods of expansion.
Nervous yet? You’re not alone. The ongoing selloff in stocks has prompted investors to pay the most since the 2016 presidential election to protect against a decline.
If you want to start hedging but are unsure how to do it, be sure to check out Business Insider’s recent guide.