The Long Short Tsunami

Hedge Funds that run a long/short strategy have been in a living hell since the S&P 500 bottom on February 11th. Why?

A very simple fact. Most got caught with their pants down. How do I know this fact? I see it in weekly numbers we track through Erlanger Research.

The worst scenario for a long short fund is to have their longs go up in value but see the shorts go up even more. My label for this is the “long short tsunami”.

In tracking, “short squeeze” stocks they were down -17.71% through the February 12th close. Meanwhile stocks where the “shorts were correct” fell -19.80%. So if you were buying short squeeze names and shorting heavily shorted stocks that were going lower you were up 2.09% through February 12th.

The S&P 500 in that same time period was down -8.77%. Such a deal. You were a happy camper as you were beating the S&P 500 by 10.86%. Your investors thought you were a god. Now let’s flash forward to last Friday’s close on March 18th. That spread of 10.86% is gone.

Now your long short book is losing -8.82% for the year and trailing the S&P 500 by 9.10%. That is a tough pill to swallow. Instead of being a happy camper suddenly you are worried if you are going to be in business next quarter. You are no longer a god rather you are a piker struggling with the masses.

The definition of insanity is doing the same thing over and over when you know the outcome. Long short guys know that they are going to have weeks and months like they just saw yet they do nothing to remove themselves from getting squeezed.

Such “upside down” outcomes happen typically once a year. Given the current volatility, I expect to see more of this type of action. So the action we saw from mid February into this week, might repeat itself if we plunge another couple hundred of points on the S&P 500. A strong likelihood if the Federales one week talk dovish and the next week turn Hawkish.  It seems the Federales need to be put on Prozac so they can remain calm with a consistent voice. Trying to manage an economy through the stock market is no way to go through life Mrs. Blutarski.

In my next column, I will discuss how to come aware that the long squeeze tsunami is about to commence. Suffice it to say, a big piece of the strategy revolves around understanding measures of oversold as well as tracking a variety of sentiment measures.

Remember it is always darkest before the dawn and if you are a vampire sucking the blood of others you better get back inside before the first rays of sunlight creep across the horizon.

If you enjoy the content at iBankCoin, please follow us on Twitter