Stansberry Research

Institutions Are Poorly Positioned For a Stock Market Rally

C. Scott GarlissStansberry NewsWire

The S&P 500 Index is facing another important test over the next few weeks...

We're in the thick of fourth-quarter earnings right now. The process got underway with JPMorgan Chase's (JPM) results on January 13 and will wrap up when Disney (DIS) posts its numbers on February 8.

So, we want to look at positioning to see what institutional investors are anticipating ahead of the results. Observing these metrics, it gives us a better idea of the setup. And when we understand the data, we get a clearer sense of what the stock market outcome may be if results don't fare as well as (or as poorly as) most investors are anticipating.

Every Friday at 3 p.m. Eastern time, the Commodity Futures Trading Commission ("CFTC") releases its Commitment of Traders ("COT") report. It's based on the open interest of all options and/or futures contracts through the prior Tuesday. It also includes any futures market where 20 or more traders hold a position equal to or above reporting levels established by the CFTC and the respective exchanges.

But we especially want to follow the noncommercial positioning. A commercial trader uses futures-contract positioning to offset a specific commodity or hedge. But noncommercial traders are speculators who make a one-sided bet without an offsetting position. These are typically hedge-fund managers.

The best way to get an idea of current sentiment in the stock market is to study the open interest on the S&P 500. Based on the most recent report, fund managers are almost as short stocks as they were at the COVID-19 pandemic lows. In fact, those short bets have increased since the start of this year...

The current positioning is short more than 226,800 contracts. That tells me those money managers are anticipating the S&P 500 is headed lower... They're expecting earnings to disappoint. But as the chart shows, the last time they were more pessimistic was just after the stock market bottomed in April 2020 and the recent trough in October 2022.

The five-year average is long right around 16,500 contracts. So, if those bets against the S&P 500 are wrong, there's a lot of room for the market to move higher because of the consequent short covering that could take place.

Next, let's look at the amount of investor assets sitting in cash. We can observe this by looking at the Investment Company Institute's money-market fund assets. And as you can see, the number hasn't been this high since May 2020...

Currently, the total amount of funds invested in the cash-like safety of money-market fund assets is $4.8 trillion. That's right in line with the $4.8 trillion total during the height of the COVID-19 pandemic. It's also well above the five-year average of $3.9 trillion and the one-year number of $4.6 trillion.

More importantly, that's a signal there's a lot of excess capital waiting to be put back to work. By sitting in money-market fund assets, those funds are making little to no return. If the stock market keeps rallying, those investors are missing out on gains. Eventually, they'll be forced to chase as stocks move higher.

Lastly, let's look at investor positioning in U.S. equities from January's Bank of America Global Fund Manager Survey. It has only been this cautious five other times in the last 25 years. Take a look...

And when that has been the case, the returns on the S&P 500 have exceeded the lifetime average of around 9.1%...

Remember that stocks are the ultimate barometer of performance versus investor expectations. When expectations are high, they're hard to beat. When they're low, they're difficult to underperform. And based on what we're looking at, numbers better be awful.

Otherwise, all those assets sitting in cash will be missing out on returns. When that happens, it will slowly but surely start trickling back into stocks. And before we know it, that steady stream will turn into a flood that fuels a rally in the S&P 500.