Hedge fund trades still feeling bruised from day traders' punts

Trades associated with hedge funds were under pressure again in Friday’s stock selloff, though with less intensity than earlier in the week, Bloomberg reports.

The most visible evidence was a rally in companies with the highest short interest, a basket of which climbed 2 percent, according to data compiled by Goldman Sachs Group. Names that had burned bearish hedge funds, from GameStop Corp. to AMC Entertainment Holdings Inc., bounced back after some brokerages lifted trading restrictions on the shares.

Elsewhere, an exchange-traded fund tracking the industry’s favorite stocks (GVIP) fell by about 2 percent, roughly in line with the market.

While the pain paled in comparison with Wednesday, its persistence is a continuation of this week’s theme, in which professional investors have suffered at the hands of day traders banding together in chat rooms. Despite a rush to cut risky bets in a process known as degrossing, hedge fund selling has yet to reach levels that signal the cycle is over, according to data compiled from Morgan Stanley’s prime brokerage unit.

“While we may not follow the same pattern this time, the main point is that several big days of degrossing are not always the ‘end’ of the period as degrossing usually persists, but typically in lesser magnitude, for several weeks to months after,” the firm wrote in a note. “Historically, there’s been continued active degrossing that occurs after the initial shock.”

With day traders waging war on heavily shorted stocks, professional speculators have been forced to dump holdings on the long side of their portfolios. Still, gross leverage, a measure of industry risk appetite that takes into account both bullish and bearish wagers, remained elevated, partly because the short side of the book kept swelling because of a rally in shares such as GameStop. At above 200 percent, leverage is near all-time highs, Morgan Stanley data show.

At Goldman, clients experienced the biggest one-day decrease in gross leverage on Thursday. Still, at 237 percent, leverage sat in the 96th percentile of a one-year range.

At JPMorgan Chase & Co., client degrossing also seemed limited, with four-week flows having yet to register as a 1 standard-deviation event. While the size of covering in highly shorted stocks would suggest it’s closer to an end, it isn’t clear that bears broadly have been exhausted, according to a JPMorgan note.

“The bigger risk seems to be where the recent long selling that started in earnest this week has to persist for a while longer,” JPMorgan wrote. “The fact that this is not occurring during a broader market weakening in the macro backdrop makes it harder to gauge how much further this should go.”