To The Moon

After about 1 month of rally, policy expectations are signaling a reversal and U.S. stocks are beginning to retreat.

Highlights

1. The Fed believes that inflation remains at a disturbingly high level, and officials reiterated determination to keep prices down.
2. Institutions are concerned that rate hikes may exacerbate the risk of a potential recession and thus impact the stock market. 
3. Retail investors may face a new round shock from shorting funds.

1. Retail Investors Remain Active

Since the Fed's June resolution, US stocks have enhoyed a rebound, with $NASDAQ(.IXIC)$ rebounding nearly 25% from its low and once entered a technical bull market.

High enthusiasm from retail investors is an important factor driving the rally.

According to Vanda Research,

retail investors' purchases are now averaging $1.36 billion a day, and the rolling 21-day average is above $27 billion.

Investors' frenzy in Meme stocks such as $Bed Bath & Beyond(BBBY)$ , GameStop and AMC reached a climax last week.

In the case of $Bed Bath & Beyond(BBBY)$ , Vanda Research said individual buying and call option trading volume spiked to more than 70x of its historical average in the past.

However, analysts said that:

"Retail investors' influence on the market will wane, and the stock market will likely see more tug-of-war starting in late August when most institutional investors return from their summer vacations."

2. Analysts Are Bearish On The Stock Market

Boris Schlossberg, macro strategist at BK Asset Management, said that while U.S. stocks will not necessarily test the lows of the first half of the year, investors should not be too optimistic.

"Looking at the trend in US Treasury yields, investors are betting that the Fed will continue to raise rates sharply because consumer demand remains strong and inflation is still hot. The potential risk is that the Fed will overreact in controlling demand, which in turn could hit the economy."

Goldman Sachs believes that inflation data and the economic growth will drive stock market movements in the second half of the year. But after the best summer rally ever in US stocks, they see limited room for continued gains.

David Kostin, chief U.S. equity strategist at Goldman Sachs, said

"A renewed flood of recession fears will almost certainly reverse the recent rally."

Citi strategist Dirk Willer noted that U.S. stocks have recovered most of their losses from the first half of the year, but they will turn down again due to the recent resurgence of market fears of rate hike, advising investors to reduce their holdings.

"The current bear rally in U.S. stocks is almost in line with the average duration of previous bear rallies. It suggests that this bear rally in U.S. stocks could end relatively soon."

3. Hedge Funds Short Positions Reaches $125 billion

Data shows that institutions are increasing their shorting positions, betting that the current rally in U.S. stocks will come to an end.

According to the latest statistics from BNP Paribas,

Institutional short positions against US equities have exceeded $125 billion, up $18 billion from a year ago.

Greg Boutle, head of U.S. equity derivatives strategy at BNP Paribas, said that many positions "remain on the defensive" and highlighted the increasing short positions on U.S. stocks.

According to financial data provider Refinitv Lipper data,

the last three months, global capital flows continue to show a strong interest in "shorting preference" investment.

In July, inflows to Lipper's dedicated short funds were approximately $3.2 billion, the highest since April 2020, as the Federal Reserve raised interest rates and investors questioned the durability of the U.S. economy.

According to Refinitiv Lipper,

The average return of The Diversified U.S. Equity Fund was -14.2% this year, but its short fund grew 8.8% over the same period.

It's important to note that headwinds remain. Most importantly, the Fed has a lot of work to do to reduce inflation.