Eye on the Market October 12, 2011 J.P. Morgan Topics: Is the recent rally anything more than short-covering, given ongoing risks in the US and Europe? The S&P 500 is up 9% and European equities are up 16% since their lowest levels of the last month. There has been some mildly better than expected economic data in the US, and more talk of a plan in Europe to recapitalize banks. However, it appears that "short covering" has played a large role in this recent rally. Markets often bottom with short-covering preceding real money buying, so there's nothing wrong with that. But it's worth considering the technical factors in play before trying to interpret what the recent rally might mean. The charts below highlight some of the technical factors we look at: short interest on the S&P 500 ETF, short interest on S&P futures contracts by speculative investors on futures exchanges, and a proprietary measure of hedge fund risk appetite compiled by ISI. [See Appendix for sources and definitions]. [1] Short interest on S&P 500 ETF Percentof shares outstanding 90% 80% • 70% - 60% • 50% • 40% 30% • 20% Jan-08 Jan-09 Jan.10 • Jan-11 I $10 $0 -$10 -$20 -$30 $40 Jan-08 Jan-09 Jan-I0 Jan-II [4] S&P 500 futures market volume [5] S&P 500 futures market depth 20-day m a, BillionS, USD Number of contractswithin+/- 125, 20-day ma $240 12.000 $220 $200 • if 10,000 $180 8000 $160 ..? $140 • $120 • •4 b t 6.000 4,000 $100 • 2 $80 • ,000 $60 • 0 Jan-08 Jan-09 Jan-10 Jan-11 Jan-08 Jan-09 Jan-10 Jan-11 [2] Net long speculative positions on PI Bullish sentiment of S&P 500 S&P 500 futures, Billions. USD futures positions, Net long/short, % $20 120° 100% 60°i 60% 40% 20% 0% 20% 40% -60% Jan-08 Jan 09 Jan 10 Jan 11 [6] Hedge fund net exposure survey Index, 50 = 'normal" 56 54 46 44 42 40 Jan 08 Jan-09 Jan-10 Jan-11 In aggregate, these charts suggest that short interest was quite high in September when t