Capitulating Bears Push Short Sales to Lowest in Three Years

The biggest Standard & Poor’s 500 Index rally in more than five decades is forcing stock market bears to abandon short sales, cutting them to the lowest level since 2007 last month.

Shares borrowed and sold to profit from declines dropped four straight months and represented 3.3 percent of all stock in January, according to data compiled by NYSE Euronext. Pessimists are giving up after missing the 95 percent rally in the S&P 500 spurred by the fastest earnings growth since 1994. The monthly decrease comes as individuals added $17.6 billion to U.S. mutual funds this year after withdrawing money since April.

While short sales rose 2.8 percent in the two weeks ended Feb. 15, January’s low may foreshadow slower gains in equities as the pool of new investors shrinks, according to Doug Burtnick of Aberdeen, Scotland-based Aberdeen Asset Management Plc. To Laszlo Birinyi of Birinyi Associates Inc. in Westport, Connecticut, levels haven’t fallen enough to reverse gains or stop equities from climbing as the economy expands.

“When everybody is leaning on the same side of the boat, then there’s a risk things may go in the other direction,” said Philadelphia-based Burtnick, the senior investment manager of a fund that seeks to profit from both rising and falling stocks at Aberdeen, which oversees about $287 billion. “The market’s liquidity-driven tailwind has made people very careful on how they want to position themselves.”

Building Bulls

There are about 12 times as many investors speculating on gains in U.S. shares as there are on declines, a three-year high, according to New York-based Data Explorers, which provides research on short sales and stock lending. The firm’s long-short ratio for U.S. equities rose to 12.4 on Feb. 1 from 6.5 in September 2008 when Lehman Brothers Holdings Inc. collapsed at the height of the financial crisis.

“The appetite to short has waned as the market has risen,” said Will Duff Gordon, a senior researcher at Data Explorers. Individual companies and industries may be overvalued, “but with most companies in robust health it is not a target-rich environment,” he said.

The S&P 500 slid 1.7 percent to 1,319.88 last week. Violence that left more than 1,000 people dead in Libya sent oil above $100 a barrel, spurring the S&P 500’s first weekly loss in a month. The slump cut the U.S. equity benchmark’s advance for 2011 to 5 percent, still the best start to a year since 1997.

Stocks Climb

Stocks rose today as billionaire investor Warren Buffett said he’s looking to make acquisitions and reports signaled a strengthening American economy. The S&P 500 climbed 0.6 percent to 1,327.22 at 4 p.m. in New York.

The 46 most-shorted companies in the S&P 500 have risen 32 percent since Aug. 26, the day before Federal Reserve Chairman Ben S. Bernanke signaled he was willing to buy Treasuries to stimulate the economy, data compiled by Citigroup Inc. in New York show. That compares with 26 percent for the index.

Netflix Inc. has rallied 69 percent since Aug. 26 to $212.44 while bearish bets climbed to 25 percent of shares available for trading, making the Los Gatos, California-based movie-rental service the third most-shorted stock in the S&P 500. AutoNation Inc., the largest U.S. car retailer, has the highest level in the index at 31 percent. The Fort Lauderdale, Florida-based company jumped 46 percent to $33.51 since Aug. 26.

‘No More Gasoline’

“When short interest hits an all-time low, you always get concerned that a momentum rally is nearing exhaustion,” said Andrew Baehr, head of North America structured sales at BNP Paribas SA in New York. “Capitulation of shorts helped fuel this rally from the start, and now there’s no more gasoline.”

Bears aren’t giving up fast enough to halt the bull market, according to Birinyi. His research and money-management firm was one of the first to tell investors to buy stocks before the S&P 500 rallied from a 12-year low of 676.53 on March 9, 2009.

“I don’t see a wholesale capitulation of the short sellers,” Birinyi said. “We’re still far from the 1 or 2 percent short interest which characterized most of the 1990s and the previous decade. The bears haven’t thrown in the towel.”

Shares sold short have made up 2.3 percent of the U.S. stock market on average since 1995, according to data compiled by NYSE. The level was 1.9 percent from 1995 to December 2007. The world’s largest economy shrank 4.1 percent from the fourth quarter of 2007 to the second quarter of 2009, the most during any recession since the 1930s, according to the U.S. Department of Commerce. Short interest peaked at 4.9 percent in July 2008.

Positive Impact

Bearish bets have held steady when adjusted for lower stock trading. They amount to 2.9 times the average daily volume on U.S. exchanges this year, data compiled by Bloomberg show. The level compares with a median of 2.8 in the past three years.

“If the equity rally continues, we expect the positive impact of short covering to be the same,” said Pierre Lapointe, a strategist with Brockhouse & Cooper Inc. in Montreal.

Short selling started to decrease as stock gains accelerated at the end of August. Increased banking regulation and stricter collateral requirements also reduced bearish bets, said Michael Gordon, who oversees about $65 billion as chief investment officer of equities at BNP Paribas Investment Partners in London.

Goldman Sachs Group Inc. shut its Principal Strategies unit that made bets with the New York-based bank’s own capital to meet U.S. regulations curbing risk-taking, the company said Oct. 19. New York-based Morgan Stanley said last month that it plans to break off its largest proprietary-trading group as an independent advisory firm by the end of 2012.

‘Prop Trading’

“The fourth quarter effectively seemed to be the end of prop trading for the investment banks,” said Gordon, who was previously Fidelity International Ltd.’s global head of institutional investment.

Individuals have added $17.6 billion to U.S. mutual funds this year, following $94.7 billion in withdrawals during the last eight months of 2010, according to the Washington-based Investment Company Institute. The inflows this year are the first since April, when the S&P 500 began a 16 percent decline through July.

The S&P 500 has fallen 0.7 percent on average in the 60 days after mutual fund inflows were at least January’s level of $6.1 billion, based on 10 years of ICI data tracked by Bloomberg. The figures compare with a 0.9 percent advance in the two months following withdrawals of that much.

“Most short sellers are professional money managers and the trend right now is don’t be short, so they’re going to ride that trend,” said Michael Gibbs, the Memphis, Tennessee-based chief equity strategist at Morgan Keegan Inc. “It’s verifying what all the other sentiment indicators are saying, which is that retail investors are becoming more bullish. But these indicators only tell you that the seeds may have been sown for a pullback. They don’t tell you when.”

To contact the reporters on this story: Lynn Thomasson in Hong Kong at lthomasson@bloomberg.net; Nikolaj Gammeltoft in New York at ngammeltoft@bloomberg.net

To contact the editors responsible for this story: Nick Baker at nbaker7@bloomberg.net; Nick Gentle at ngentle2@bloomberg.net

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