Hedge funds again shorting risky tech after rally forced unwinding

NEW YORK – Professional speculators are not convinced that the worst is over for one risky corner of the stock market despite a rousing new year rally. 

Hedge funds that make both bullish and bearish equity wagers have returned to betting against unprofitable technology shares in February after being forced to unwind some positions earlier. Thanks to the increase in shorts, their overall exposure to these companies fell close to the lowest level since 2018, data compiled by Morgan Stanley’s prime brokerage shows. 

“The short covering has been isolated to a few trading days, but we haven’t seen the widespread reduction in crowded short exposure that one might expect given how sharply the high-short interest names rallied,” Morgan Stanley’s team including Mr Bill Meany wrote in a note to clients this week. Hedge funds “are still running high levels of short leverage despite their efforts to cover shorts”. 

The move reflects a broadly cautious stance among big money managers despite an equity bounce that has defied gloomy warnings. As stocks recovered into the new year, countering strategist calls for a first-half sell-off, hedge funds tracked by Morgan Stanley have trimmed short positions on the index level to capture the upside.

Yet for individual stocks, their short exposure stayed elevated and, even on the long side, it is defensive and large-cap shares that were favoured.  

Mr Meany and his colleagues observed three sessions of big short covering this month – the first two and on Feb 15. Since then, however, hedge funds have added enough shorts to offset two-thirds of what was covered on these days. 

For now, the renewed shorting is paying off. A Morgan Stanley index tracking unprofitable tech stocks has dropped more than 5 per cent since Friday, handing gains to bears for only the second time in seven weeks. 

Still, with the cohort of stocks up 17 per cent this year, it is hardly a win. If anything, the persistent bearishness set the stage for another rally should momentum reverse again. 

But hedge funds can be forgiven for sticking to their guns. Thanks to higher interest rates, betting against expensive stocks proved to be a winning trade last year as investors fled companies such as Okta Inc and Asana Inc. As a group, shares of unprofitable tech firms plunged more than 50 per cent in 2022.

While speculation over rate cuts breathed some life into risky assets this year, that optimism is now fading with bond traders ratcheting up bets that interest rates may peak at a higher level. That is not good news for stocks that have no earnings as a buffer when the pressure on equity valuations keeps growing. BLOOMBERG