The rebound of US stocks is not a vote of confidence! Short covering creates a "false prosperity", and it may be difficult for the upward trend to continue.

When the U.S. stock market rebounds from the sell-off in the midst of lingering uncertainty, there is often a hidden aggressive buyer behind the rally - the short seller forced to cover. For example, the "most-shorted stocks basket" compiled by Goldman Sachs Group, Inc. has surged 16% this month, far outpacing the 0.7% gain of the S&P 500 index during the same period. Based on data since 2008, this performance is expected to make the basket of stocks set for the strongest October performance in history. Founder of Hedge Fund Telemetry Thomas Thornton said, "Shorting this market is really difficult because this rebound seems endless. The feeling of being slapped in the face by the market every day is painful and frustrating." Reportedly, he holds a small net short position on the S&P 500 and Nasdaq 100 indices. Over the past six months, the S&P 500 index has almost ignored all warnings, achieving one of the strongest interim performances since the 1950s. However, the rare difference between the S&P 500 index and the "most-shorted stocks basket" in the month so far indicates that some investors are covering their short positions before the Federal Reserve's rate decision on October 29. Although such aggressive covering behavior typically boosts the overall market, this dynamic may create a false "confidence vote". In fact, the market still has no clarity on President Trump's trade agenda or the Fed's policy direction. Entering October - historically the most volatile month - derivative market data shows that traders have been paying higher premiums to hedge against "surges" rather than "plunges". However, this trend is changing. Although the S&P 500 index rose 1.7% last week, risk aversion sentiment has now increased. Cboe Global Markets Inc.'s global market derivatives market intelligence chief Mandy Xu and her team wrote in a client report on Monday that traders are raising money for downside protection by selling call options. Thomas Thornton pointed out, "Everyone is betting that the Fed will cut rates again, but many are overestimating the stimulative effect of rate cuts on the economy, as policymakers may not be able to significantly reduce borrowing costs as Wall Street hopes." Despite recent volatility, the S&P 500 index is less than 0.3% away from its all-time high. Previously, positive progress in trade negotiations with China hinted by the White House and robust earnings reports from multiple regional banks alleviated concerns in the market over credit risks. On Monday, the Cboe Volatility Index (VIX), which measures the implied volatility of the S&P 500 index, fell below the key 20-point mark after briefly reaching its highest level since April last week. Currently, both quantitative trading programs and human investors are reducing their exposure to U.S. stocks, mainly due to the unusual divergence observed this summer. At that time, systematic quantitative funds based on momentum and volatility signals were bullish on stocks, while subjective investors assessing economic and earnings trends remained cautious. However, overall stock positions saw the largest weekly decline since early April last week, falling from "moderately overweight" to "neutral". The team led by Deutsche Bank Aktiengesellschaft strategist Parag Thatte noted that subjective investors have shifted from neutral to underweight. However, this also leaves them ample room to return to the buy side in the future. Parag Thatte said, "Subjective investors have a lot of room to maneuver and will eventually increase their stock exposure and buy on dips. They are still concerned that the economy or corporate earnings may be at risk, but if corporate earnings remain strong, they will increase their buying in U.S. stocks." Quantitative traders using systematic strategies have reduced their positions from high levels to moderately overweight. The equity exposure of trend-following funds (CTAs) fell again last week to the 83rd percentile of its multi-year range, the lowest level in three months. Parag Thatte added that if the next move for CTAs is to take profits and unwind extreme positions, it may lead to a temporary market pullback. However, the S&P 500 index would need to fall at least 3% to 5% from current levels to trigger a massive sell-off by CTAs. Meanwhile, the most speculative sectors in the market are soaring. The "unprofitable tech basket" by Goldman Sachs Group, Inc. - including companies like Roku (ROKU.US) and Peloton Interactive (PTON.US) - has also risen 16% since October, according to data since 2014, these basket stocks are also set to achieve the best October performance in history. Thomas Thornton said, "If investors flock to these speculative sectors highly correlated with the most shorted stocks, they are actually taking on higher risks and ignoring the fundamental reasons why these stocks are being shorted." "The risk of a market pullback could come at any time. The specific trigger is unpredictable, but the question is not 'if' but 'when'."