Pre- and Post-election activity was relatively consistent between the two largest major market ETF’s, but most of the volatility and movement came in the Spider S&P 500 ETF (SPY US) and not the iShares Russell 2000 ETF (IWM US).
In the week before the election, November 1st through November 8th, long holders increased their position slightly in the two ETF’s, by $585 million, while short sellers put on $8.9 billion of new exposure. In the aggregate, we saw a bearish sentiment of $8.3 billion in long/short activity in advance of the Presidential election. It seems that since traders could not predict the outcome with any certainty, they decided not to increase their long holdings and instead increase their short hedges.
After the election, November 9th through November 14th, not only did the shorts reverse out $9 billion of their newly put on hedges, the longs jumped into the deep end of the pool and put on over $18 billion in long exposure. Trader’s views in the last week were decidedly bullish with $27.4 billion of new upside activity.
As you can see by the long and short ETF flows, most of the activity occurred in the SPY S&P 500 ETF rather than the broader IWM Russell 2000 ETF. Post-election trading activity, both long and short, was over five times larger in the SPY than the IWM. But performance in the large cap ETF lagged the broader market ETF by over seven to one. In hindsight, it would have been more advantageous to both hedge prior to the election and put on alpha after the election using the broader Nasdaq IWM ETF.
Small caps have underperformed large caps for over a decade and while the ‘small firm effect’ may not work well over long periods it may outperform in shorter durations when volatility from extraordinary market/political events negatively affects the alpha of larger “premier” securities more than their smaller counterparts. For example, the FANG stocks, which make up 6.1% of the S&P, are down an average of 7.2% after the election.
One of the main reasons is the crowded nature of long large cap holdings among larger institutional investors which creates a domino effect of selling as prices move against them. Secondly, the general liquidity of these assets lend themselves to be the vehicle of portfolio risk rebalancing as an institution can sell large blocks of these highly traded stocks without moving their bid-ask significantly. Thirdly, the earlier outperformance by the larger caps let long holders sell out “winners” and realize/lock in profits in names that may have already hit analyst’s target levels rather than sell out small cap “losers” or small/mid cap stocks where analysts still see a profitable run. But in this case, one of the main reasons for their underperformance is the potential that these specific companys’ bottom lines may be hit hardest by changes in the new regulatory, tax and economic environment that will be initiated by the new presidential administration.
We should see aggregate long and short exposure in the SPY and IWM ETF’s remain fairly stable as long as this rally continues, but if there is a short term plateau or dip in the market accompanied with a reversal of last week’s ETF inflows and short covering we might be seeing a signal of a market reversal.
For more information on the above analysis, please contact:
Ihor Dusaniwsky, Head of Research, S3 Partners, LLC Ihor.Dusaniwsky@S3Partners.net
The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC ('S3 Partners') to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks and merits, as well as the legal, tax, accounting and investment consequences, of such decision.