(Bloomberg) — Warnings embedded in strategist price targets and historically low U.S. stock volatility are doing nothing to dissuade hedge funds.
They just spent another week adding to long positions in the equity market and building up shorts against the CBOE Volatility Index that were already at a record, according to data from the Commodity Futures Trading Commission. Stocks languished for most of Tuesday before extending gains in the final minutes of trading, as the S&P 500 Index added 0.3% to 2,186.48 as of 4 p.m. in New York. The Nasdaq Composite Index advanced 0.5% to a fresh record.
The positioning leaves the biggest speculators at odds with an increasingly skeptical analyst contingent on Wall Street, with the average strategist forecast sitting about 1.5% below the market's closing level. It also puts them in the awkward position of betting on declines in a volatility gauge that in August posted one of its lowest average readings on record.
"The market has gotten increasingly frustrating for hedge funds with a bearish bent," said Michael James, managing director of equity trading at Wedbush Securities in Los Angeles. "You're seeing them throw in the towel and subscribe more to the thesis of a further grind higher. There are diminished expectations of significant volatility or a market pullback."
Large speculators extended bullish contracts on the S&P 500 to the most since May 2013, CFTC data show. The measure has been above zero, which delineates bullish from bearish, since mid-April. At the same time, VIX positions showed an expectation for low volatility even though the so-called fear gauge averaged 12.4 in August, the lowest monthly average in more than two years.
The ongoing hedge-fund bullishness conflicts with the views of Wall Street equity strategists, who see the S&P 500 slipping from its current level to end the year at 2,150, according to estimates compiled by Bloomberg. The biggest bear, Ben Laidler of HSBC Holdings, foresees the benchmark losing 10% to 1,960 by year-end.
Amid the underlying strategist pessimism, stock bulls received a boost on Friday when August payroll data signaled steady labor-market growth, although not enough to force the Federal Reserve to raise interest rates. The central bank's reluctance to hike borrowing costs ahead of the November presidential election has been a boon for U.S. equities slogging higher, as mixed economic data has neither inspired the Fed to act, nor given investors cause to sell.
Data on Tuesday showed services industries expanded in August at the weakest pace since February 2010, joining manufacturers in an abrupt slowdown that may signal waning optimism about the economy. That sent bond yields lower, dragging banks to their worst drop in almost four weeks. Wells Fargo and Bank of America lost at least 1.1%.
Mergers dominated corporate news Tuesday, boosting energy and health-care companies. Spectra Energy rallied 13% to a two-year high after agreeing to a $28 billion stock-for-stock transaction with Enbridge Cepheid jumped 53% after Danaher agreed to buy the company in a deal valued at about $4 billion, including debt. The Dow Jones Industrial Average rose 46.16 points, or 0.3%, 18,538.12. About 6.6 billion shares traded hands on U.S. exchanges, in line with the three-month average.
"We're still dealing with the ramifications from the jobs number," said Michael James, managing director of equity trading at Wedbush Securities in Los Angeles. "It was an exhale of relief that the number wasn't too hot, diminishing the chance of a September rate hike. Price action will probably be dictated by the data we have forthcoming."
Investors are assessing the potential effects of a Fed hike while central banks across much of Europe and Asia are in the midst of easing cycles. Fed-funds futures currently reflect a 24% chance the Fed will increase borrowing costs at the September meeting, down from 36% before the services data. Odds had reached as high as 42% late last month. The first meeting with a better-than-even chance of a hike is in December.
The S&P 500 has been treading water since reaching a fresh record in mid-August, amid monetary-policy speculation and lackluster data. The gauge has held in a band of 1.5% for 38 days, the narrowest ever for that length of time. It closed Tuesday less than 0.2% from its all-time high. The VIX rose 0.3% to 12.02, following its biggest one-day drop in two months.
Among other shares moving on corporate news, Navistar International soared 41%, the most ever. Volkswagen AG is buying a stake in the company to gain a foothold in the U.S. heavy-truck market, as the German automaker still grapples with the fallout from the emissions-cheating scandal. Engine maker Cummins, a supplier to both companies, lost 7.3%, its steepest in nine months.