Short Sales Decline 53% as Bull Market Enters Fifth Year
Short sales in the Standard & Poor’s Composite 1,500 Index fell to 5.6 percent of shares available for trading in February, down from a record 12 percent during the credit crisis and the lowest ever in data compiled by Bespoke Investment Group and Bloomberg starting six years ago. The last time the number of shares borrowed and sold short approached this level, the equity gauge lost 3.3 percent in the next three months.
Bulls say the capitulation by market bears shows the rally remains intact and that more money will flow into stocks after individuals sent $37.9 billion to mutual funds in January, the most since 2004. It also means a source of demand is diminishing, a traditional signal for caution in an aging bull market. Less than one percent of the shares of Ford Motor Co. and Cabot Oil & Gas Corp. (COG) have been borrowed and sold short by speculators hoping to return them to owners once prices fall.
“When you look at short interest, and it’s low like right now, it means people are very, very bullish about the market,” Uri Landesman, president of New York-based hedge fund Platinum Partners, which manages $1.15 billion, said in a Feb. 28 phone interview. “When that happens, it’s a bearish sign, because if all minds change, there’s downside, not upside.”
Stocks gained last week, with the S&P 500 Index (SPX) rising 0.2 percent to 1,518.20, bringing the 2013 increase to 6.5 percent. The index is up 124 percent from March 2009, when it reached a 12-year low of 676.53 and ended the worst bear market since the Great Depression. The gauge rose 0.5 percent to 1,525.20 today.
Almost $10 trillion has been restored to U.S. equities as retailers, banks and manufacturers led the recovery poised to enter its fifth year this week. The benchmark gauge for U.S. equities is about 3 percent from the all-time high of 1,565.15 hit in October 2007.
Gains since 2009 came as the Federal Reserve held its benchmark target interest rate for overnight loans between banks near a record low and 10-year Treasuries yielded 1.84 percent last week, compared with the decade average of 3.62 percent. The central bank has used low rates and unprecedented bond-buying to push investors to riskier assets where returns have been higher. The S&P 500’s return since 2009 compares with 17 percent for Treasuries, according to Bank of America Merrill Lynch Indexes.
Investors are adding to U.S. stock mutual funds after pulling out almost $400 billion the past four years, data from the Investment Company Institute in Washington show. About $16.3 billion went into stock funds the first three weeks of February, with about $2.5 billion to U.S. equities, the trade group said last week.
Laszlo Birinyi, one of the first money managers to tell clients to buy before the bull market began, says individuals will push stocks higher even as the rally ages and a lack of short covering fails to elevate prices. Investor sentiment isn’t “overly optimistic” and the market should exceed the all-time high this year, Birinyi said.
“The idea that the public is wrong at the turns and a contrary indicator is not true,” Birinyi said in the March Reminiscences newsletter emailed Feb. 28. “The public is not the only source of funds and the individual has not necessarily made a wholesale commitment to stocks,” he added. “We continue to look for more gains.”
Betting on declines has proven unprofitable. A gauge of the most-shorted U.S. companies compiled by Goldman Sachs Group Inc. has rallied about 9 percent in 2013. In the S&P 1,500 (SPR), the proportion of shares borrowed and sold short has been declining since the middle of last year.
For each share speculating on losses in U.S. equities, there are 14 betting on gains, near the highest level in at least five years, according to data compiled by Markit, a London-based research firm.
“Stocks are reflecting optimism in the economy, so there are less opportunities to short,” Sarat Sethi, a fund manager with New York-based Douglas C. Lane & Associates, which oversees $2.6 billion, said in a telephone interview on Feb. 19.
Price swings for U.S. stocks are narrowing the most since the Great Depression as the economy shows signs of improving. The Federal Reserve’s zero-interest-rate policy pushed purchases of new homes in January to the highest level since July 2008, and consumer confidence rose more than forecast.
While investor optimism increases, corporate earnings may not be expanding fast enough to justify additional mutual-fund deposits, said Jason Brady, a managing director at Thornburg Investment Management in Santa Fe, New Mexico, which oversees $83 billion.
“The larger question to me is do the fundamentals support that move?” Brady said in a Feb. 27 interview. “And there I’m not so sure.”
Earnings for companies in the S&P 500 are poised to decline 1.7 percent this quarter, the first drop since 2009, according to data compiled by Bloomberg. U.S. gross domestic product will expand 1.8 percent, down from 2 percent a year ago, according to the median estimate of 70 economists in a Bloomberg survey.
The highest valuations for stocks in two years may also deter investors. The S&P 500’s price-to-earnings ratio climbed to 15.1 last month, a level not seen since May 2011, data compiled by Bloomberg show. That compares with an average of 16.4 since 1954.
The rally is extending beyond the average length, according to Birinyi data that shows bull markets since 1962 have a duration of four years. Of nine advances, four have lasted longer than the mean and the market rose for about six years during those periods.
Diminishing levels of short selling have preceded losses in the past. When the proportion of bearish bets dropped to near record low levels in March 2012 and 2011, the S&P 1500 lost 3.3 percent and 0.4 percent, respectively, during the second quarter, data compiled by Bloomberg show.
Short selling in Ford, the second-largest U.S. automaker, fell to a record 0.4 percent of shares outstanding last month, from 5 percent in December, according to data compiled by Markit. While the Dearborn, Michigan-based company gained 13 percent in December as earnings surpassed analysts’ estimates, the stock is falling now. It dropped 2.6 percent in 2013, compared with the S&P 500’s 6.5 percent advance.
Bearish bets on Cabot Oil & Gas dropped to 0.2 percent of total stock last month, near the record low, compared with more than 5 percent in May, data from Markit show. The Houston-based energy exploration company beat analysts’ profit estimates by 24 percent for the fourth quarter and the stock has gained 27 percent this year.
Borrowed shares of Adobe represent 1.8 percent of the total, down from 6.1 percent Nov. 16, according to data from Markit. The San Jose, California-based software company has rallied 22 percent since the middle of November as sales and profit topped analysts’ estimates.
For Deere & Co. (DE), the world’s largest agricultural-equipment maker, short interest dropped to 1.3 percent last week, compared with 3.6 percent in September, Markit data show. The stock is up 7.1 percent since then, compared with the S&P 500’s 4.9 percent, as the Moline, Illinois-based company boosted its dividend and posted better-than-estimated earnings.
Short sellers represent 2.4 percent of Johnson & Johnson (JNJ)’s shares today, down from 8.1 percent in June. The world’s largest seller of health-care products exceeded fourth-quarter projections when it reported Jan. 22. The stock is up 9.4 percent for 2013.
“Short interest is necessary for a healthy market,” Jeff Sica, president and chief investment officer at SICA Wealth Management, which oversees more than $1 billion, said in a phone interview from Morristown, New Jersey.
“When you have a market where investors are all in, there will no longer be short covering,” said Sica, who started reducing bearish bets in mid-2011 to the current 5 percent of assets. “As short interest has continued to decline, I see it as a sign of a market top.”
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