Chinese Quant Funds Trapped in Massive Short Squeeze Due to Beijing's 'Bazooka' & Shanghai 'Glitch'

Market Overwhelmed by China's Stimulus Measures

China's long-awaited stimulus measures may have been too much for the markets to handle. The first hour of trading on Friday saw shares soaring and turnover reaching 710 billion yuan ($101 billion). However, the Shanghai stock exchange experienced glitches in processing orders and delays, according to brokerages' messages seen by Bloomberg News. The exchange is currently investigating the reasons for these delays.

Trading Delays Send Positive Signal

Shandong Camel Asset Management Co.'s fund manager, Du Kejun, commented on the situation, stating that such a trading delay was only recalled during the 2015 rally. He noted that while it was a minor disruption to their trading, it would have been a significant annoyance for firms eager to increase their positions that day.

Surge in Trading Volumes

Goldman Sachs noted that trading volumes surged to +$9bn, which was four times the 20-day averages across the complex and larger than Tuesday. There were also +$580mm worth of inflows. This activity was primarily driven by LOs in the China ETF space, while HF activity remained relatively muted.

Quantitative Hedge Funds Hit Severely

According to Bloomberg, several quantitative hedge funds in China suffered significant losses on Friday as the nation's equities staged their biggest rally in years. Some firms experienced heavy losses because they shorted index futures for their Direct Market Access (DMA) strategies. The losses were further exacerbated by the Shanghai Stock Exchange glitch, which left them unable to sell holdings to meet margin requirements.

Recovering from Record Drawdowns

Many quants are still recovering from record drawdowns suffered during China's stock market meltdown in February. The meltdown caused their favored small-cap stocks to crash, prompting regulators to push for the DMA products to be phased out. The DMA strategy typically uses high leverage and involves holding long positions in individual stocks while shorting stock index futures.

Caught Wrongfooted by Economic Stimulus Measures

Quants were caught wrongfooted again after China's latest economic stimulus measures sparked the biggest weekly equity rally since 2008. This massive squeeze comes as a surprise since positioning is practically at record lows. Chinese equities now make up 4.5% and 6.2% of the Overall Prime book's Gross and Net Exposures, respectively, which are both at fresh 5-year lows.

Trading System Overwhelmed

According to Hao Hong, chief economist at Grow Investment Group, the trading system is simply overwhelmed. There is a huge stampede of stock bulls. In cumulative notional terms since the start of 2023, Chinese stocks remain meaningfully net sold by hedge funds.

Bottom Line

China's stimulus measures and the resulting glitches in the Shanghai Stock Exchange have led to a massive short squeeze, trapping Chinese quant funds. This situation raises questions about the resilience of China's stock market and the impact of such stimulus measures. What are your thoughts on this matter? Do share this article with your friends and sign up for the Daily Briefing, which is delivered every day at 6pm.