As the S&P 500 breaks through previous highs, some under-invested traders may enter the market to chase gains, becoming a supplementary force driving this round of rebound.
Written by: Xu Chao, Wall Street Insights
The S&P 500 index has continuously broken historical highs under the influence of a short covering wave, while the Nasdaq 100 index has yet to catch up. Bloomberg macro strategist Simon White believes that there are still a large number of open short positions in the Nasdaq, and once stop-loss orders are triggered, it could become the next driving force for the index to reach new highs.
The S&P 500 index surged significantly for two consecutive trading days this week, rising 1.5% on Monday and then another 1.8% the following day, strongly breaking through previous highs. This concentrated rapid rise has clear characteristics of short covering—stop-loss orders for shorts positioned near historical highs were triggered one by one, and Goldman Sachs' "most shorted" basket has risen 13% over the past four trading days, confirming this judgment.
Meanwhile, the short interest ratio for the Nasdaq QQQ ETF remains high, while the short ratios for the S&P 500 and Russell 2000 corresponding ETFs have significantly declined. Simon White points out that the intensity of short covering in the Nasdaq yesterday was not as strong as that of the S&P 500, indicating that a larger-scale liquidation may not have arrived yet. However, he also warns that inflation and real interest rate risks have not dissipated, and there is a possibility that this round of gains could turn into a "bull trap."
Short Covering Drives S&P to New Highs
The strong performance of the S&P 500 index in the past two days is closely related to the concentrated clearing of short positions in the market.
Simon White's analytical framework shows that when the market experiences a single-day increase exceeding 1.5 standard deviations of the average daily volatility over the previous month, while there is a significant decrease in open futures contracts, and the index itself reaches a new high in nearly eight weeks, it often indicates that shorts are being forcibly liquidated. This signal has already been triggered in the S&P 500.
From historical data (dating back to 1998), the average return rate one month after this signal is triggered is higher than the overall average; however, if the time window is extended to three months, six months, or even twelve months, the return rate is slightly lower than the historical average. This indicates that the upward momentum brought by short covering is relatively clear in the short term but does not necessarily mean the start of a trending market.
Compared to the S&P 500, the Nasdaq 100 index has not yet broken through historical highs, and its unfinished short covering space may be larger.
According to Bloomberg data, the short interest ratio for the Nasdaq QQQ ETF remains high in the latest data from about 10 to 14 days ago, while the short ratios for the S&P 500 and Russell 2000 corresponding ETFs have declined simultaneously. Similar analysis of open contracts for Nasdaq futures shows that the intensity of short covering for this index yesterday was relatively mild, indicating that more short positions have yet to be triggered for stop-loss.
The software sector is a typical case worth noting. Amid the rise of coding agents and thematic short selling of software stocks, the median short interest ratio in this sector has recently seen a significant jump, with related positions established relatively late, and corresponding stop-loss price levels may not yet have been reached by the current market.
In addition to short covering, previously under-allocated investors returning to the market may constitute the next driving layer of the market.
Simon White believes that as the S&P 500 breaks through previous highs, some under-invested traders may enter the market to chase gains, becoming a supplementary force driving this round of rebound.
However, he also issues a clear warning: inflation risks and upward pressure on real interest rates still exist, and the current market has the risk of evolving into a "bull trap." Investors need to remain cautious about the macro environment while chasing the upward trend.
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