How high is positioning in U.S. equities?

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Eloise Goulder: Hi, I'm Eloise Goulder, head of the Data Assets and Alpha Group here at J.P. Morgan. And today, I'm really excited to be joined by my colleague John Schlegel, who's head of the Global Positioning Intelligence team here in New York to talk all things positioning post a stellar rally in U.S. equities over the last few weeks and months. So, John, thank you so much for sitting down with us here today.

John Schlegel: It's great to be here.

Eloise Goulder: So, U.S. equities have staged an impressive rally over the last couple of months with the S&P 500 now up over 10% since August lows and in fact, up 22% year-to-date. And it's been a very pro-cyclical rally with consumer cyclicals, industrials, financials, materials, and, of course, tech really leading the charge. And my interpretation is this has been a macro-driven rally, given that we've seen consistent upgrades to economic growth assumptions for the U.S. over that period. In fact, our own economists upgraded their Q3 GDP forecasts from 1.5% to 2.5%. And, of course, we've seen very strong data points across the employment and the services sector in the U.S. as well. And this is happening at the same time as the Fed cutting rates. So, this is driving further equity strength. John, do you agree with this narrative.

John Schlegel: Yes, I generally agree. But I would add that positioning—if you look back to when this recent rally really kicked off in early August, had gotten to a fairly neutral level on a long-term basis. So there was ample room for clients to re-risk. And I think what has been a bit surprising compared to the expectations back then was just how strong the macro data had been even prior to the Fed starting to cut rates. So I think you've had a very strong U.S. story from both an economic standpoint as well as a positioning standpoint. And then you've also had strong performance out of other regions, given some of the measures that are happening in China recently as well as other parts of Asia. So, globally, maybe excluding Europe, which is a bit more mixed, there's been ample room for markets to rally on the back of these drivers.

Eloise Goulder: That makes a lot of sense. Thank you, John. And you mentioned that back in July, August positioning was looking much more neutral in U.S. markets. So who have been the main buyers of U.S. equities since then?

John Schlegel: So I think if you go back to what drove the sell-off in late July to early August, a lot of that came more from hedges that were added or futures that were reduced, so think sort of broad-based instruments trying to reduce risk into the concerns around the potential economic growth slowdown. And if you think about what's driven positioning higher since then, a lot of that is the same things that were sold. So a lot of futures that are being bought back—if you look at options in terms of the call-to-put ratios, those had turn more bearish into early August, have turned more bullish more recently. And then in the last few weeks, we've seen hedge funds even start to tick up their flows to be more positive. And this is after they had been selling from most of second half of July through middle to late September. So, in aggregate, there's a number of factors that are driving it, but I would say really macro products were the biggest drivers of the rally as we see it.

Eloise Goulder: And so where does that leave positioning today?

John Schlegel: So, in the U.S., we see positioning as fairly elevated, very similar to what we saw in early July. Our aggregate measure of U.S. positioning is just over the 90th percentile. And over the last four weeks we've seen positioning turn positive. But we're not quite at those peak levels that we saw in July. So there's definitely some room for a bit more upside at this stage but not a whole lot from a positioning standpoint.

Eloise Goulder: That's really helpful. So positioning has risen quite a lot and is now looking relatively elevated, as you say. But, on the other hand, the macro data, the micro data, and, of course, the global data, including from Asia, is looking more positive. So where does this leave overall risk-reward for markets at this stage?

John Schlegel: I think at this stage, the economic data and the fundamental data arguably could trump positioning. By this, I mean, if you think about seasonality into year end tends to be very strong. For U.S. election years, it's typically strongest after the election—so November, December. And given positioning is pretty high, I'm a bit more concerned about what markets could do over the next few weeks because there can be some choppiness. Even if you look at the last three U.S. elections, there's been a little bit of downside in the three weeks leading into the election. And just given where markets are at all-time highs and positioning having risen a bit in the last month, I think there is room for that to come off a little bit. But, overall, I think into year end, there's seasonality, strong economic growth, Fed cutting rates, China trying to stimulate their economy—all of this suggests that we could continue to rally into year end.

Eloise Goulder: Yep. So there's a lot of positives on the macro front. If we turn to thematics, arguably, we've seen some quite hawkish data points recently. We've seen higher payrolls data, we've seen a slightly higher CPI versus expectations. And so there's this risk that bond yields really widen from here. John, do you see that as a risk for market levels and in particular for certain pockets and themes within the markets?

John Schlegel: Yeah, so I think certain pockets and themes could be at risk. I think for the wider market, our view would be there is room for rates to rise from a position standpoint simply because by the mid-September period, as markets were expecting the Fed to cut but debating 25 versus 50 basis points, we had seen positioning in bonds get more long. So CTA net risk and a bunch of the different tenors were at the most net long we'd seen in a few years. And there's room for this to come down—that net length towards the long end to be reduced a bit. So U.S. rates could rise a bit further. But if you look at how the S&P 500 as a whole has acted, it usually hasn't taken on a more negative stance unless rates rise significantly. And if you look at the past couple of times when equities have sold off, it's been when rates have risen above about 4.3% in the U.S. 10-year. And so I think there is a little bit more room before we get there given where rates are today. But I think, more specifically on the rotational side, there are some areas that could be under pressure. I think some of the defensives-- especially rate-sensitive ones like utilities, which rallied a lot-- could come under pressure because of their sensitivity to rates also because positioning has gotten a lot higher for a sector like that in the third quarter. So I'd be a little bit more specific around which sectors could be hurt due to higher rates. But I think more generically, the market could be OK as long as we don't really keep accelerating higher in U.S. rates from these levels.

Eloise Goulder: And, of course, we have seen a very pro-cyclical skew to market strength over the last month or so with our cyclicals baskets outperforming our defensive baskets.

John Schlegel: That's correct.

Eloise Goulder: Thank you so much, John. So the fundamental and the macro drivers of the market are looking very robust. But, as you say, positioning in the aggregate has got that much more elevated. So are there pockets where you see more upside risk perhaps because the fundamentals are so strong or perhaps because positioning is lighter in those pockets?

John Schlegel: So I think there are three areas I point out that all are on the more cyclical end of the spectrum that could do better if the macro backdrop remains robust. But positioning in these areas are still somewhat light from our view. So the three I would call out would be, one, energy, partly because of what we see for oil positioning as well as what's happening in China. If the economy continues to re-accelerate globally, energy could be a beneficiary. I think financials in the US are another beneficiary. As long as rates don't rise too rapidly, rates stabilizing at high or levels than they were a few years back generally could be a positive for the sector and positioning overall has been reduced quite a bit. One of the key areas that we think positioning could arise is in ETFs. So ETF flows were the most negative financials in September versus other sectors and that could return more positively. And then the last one would be semis in the US. Now, this might be a little more controversial in terms of whether or not positioning is actually light. But as we see it in the aggregate, we think a lot of positioning did come out in the second half of July into early September period when semis and broader tech stocks generally underperformed the market. And we don't think it's come back that strongly yet. I think one of the most interesting data points to us is that hedge funds, which were starting to sell into the semis peak in June, have actually been buying over the last few weeks. So it suggests that more fundamental investors who saw, sort of, the top toppiness of the market back in the second quarter are now a little bit more confident in adding some risk in that sector.

Eloise Goulder: Fascinating. Thank you. So three sectors there to be watching the energy, the financials, and the semis-- all of them more pro-cyclical beneficiaries, presumably, of stronger macro data as we're seeing at the moment but also, as you're arguing, all with lighter positioning, at least versus their own histories.

John Schlegel: That's correct. Yeah.

Eloise Goulder: And then, finally, if we can turn to the other regions, you mentioned at the outset that pockets of Asia have been stronger recently, perhaps less so in Europe. Can you contextualize what you're seeing from a fundamental and a positioning angle in the other regions?

John Schlegel: So I think China is probably the most interesting and most topical at this point. We've seen, obviously, the markets there rally quite strongly over the past few weeks given the stimulus measures that have been announced and the expectation for more to come. In terms of positioning changes, at this stage, we think a lot has changed from a few weeks ago. So whether it's the flows that we see in our prime brokerage book across hedge funds, we've seen a lot of buying of local China shares. If we think about what we're seeing in futures, there's been quite a bit of directionality added and even CTAs in the Hang Seng index are now the most net long they've been since early 2021, so a 3 and 1/2 year high. I think the overall skew from a positioning lens has shifted much, much more positive in China. And there will be a lot more emphasis needed on the continuation of the stimulus measures to keep this rally going. But, clearly, if the government continues to come out with strong measures, there's a lot of potential for the retail investor in China, as I see it in particular to continue to be supportive of that market. If I think about Europe, it's a lot more mixed is the way I view it. There's not been a whole lot of performance in the absolute sense in the past few months. It's also been an underperformer versus the U.S.. But from a positioning standpoint, we've seen it right around the two-year average and so, therefore, not really striking me as something that is either wildly underpositioned or overpositioned and in line-- with a market that's been middling for the last few months.

Eloise Goulder: That makes sense. And I guess we're going to have to watch macro data from here in Europe because it's certainly not been strong in the way that it has in the U.S. recently.  

John Schlegel: Yes. And I think there's a tug of war between some of the stimulus measures in China and what that could mean for certain sectors in Europe versus the more domestic economy and some of the slowdown that we're seeing there. And so it's a bit trickier market than maybe others.

Eloise Goulder: So to summarize, then, John, you remain relatively optimistic that U.S. equities can rally further into year end, albeit they may be somewhat constrained in the near term by more elevated positioning levels. So which events and data points will you be watching from here to confirm or to refute your views? We, obviously, have U.S. elections in a few weeks, but beyond that, what will you be watching?

John Schlegel: So I think the key things will continue to be the macro data. What do we see for payrolls? What do we see for inflation? Does that continue to move in a more Goldilocks fashion and allow the Fed to continue to lower rates at a modest pace? I think, also, earnings, which are kicking off right now in the U.S., will be key. If earnings continue to beat and expectations can rise from here, I think that will support the market. And then arguably, from a global standpoint, do we continue to see some of the measures out of China remain positive for that market and help to drive a broader global growth story into year end.

Eloise Goulder: Brilliant. Well, those are very clear views, John, so thank you so much. We really appreciate all of your time and your thoughts today.

John Schlegel: It's been great having this conversation with you.

Eloise Goulder: Thank you also to our listeners for tuning in to this bi-weekly podcast series from our group. If you have feedback or if you'd like to get in touch, then please do go to our website at jpmorgan.com/market data intelligence where you can send us a message via the Contact Us form. And with that, we'll close. Thank you.

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