Hedge Funds Squeezed With Shorts Beating S&P 500Nikolaj Gammeltoft and Alexis Xydias
Speculators are abandoning money-losing bets that stocks with the closest links to the U.S. economy will fall as America’s most-hated shares stage the best rally in a year relative to the broader market.
The 20 stocks with the highest short sales in the Standard & Poor’s 500 Index rose an average of 5.1 percent in December, compared with 0.7 percent for the full gauge, according to data compiled by Bloomberg. The performance gap is the widest since January 2012. Companies from U.S. Steel Corp. to J.C. Penney Co. are gaining at the expense of phone companies and utilities, which usually do best when the economy contracts.
Market bulls say the capitulation underscores growing confidence in the U.S. recovery, while bears say the rally shows indiscriminate buying as earnings estimates fall close to a one-year low. The change echoes money manager Laszlo Birinyi’s prediction that the four-year bull market will finally attract investors who have stayed away from equities.
“Let’s put it this way, I made more money on my longs than on my shorts,” Gilles Sitbon, who helps oversee $2.1 billion at Sycomore Asset Management in Paris, said in a phone interview on Jan. 3. His Sycomore Long-Short Opportunities fund rose 15 percent in 2012. “It’s not just hard to be short, it is painful.”
Equities tend to rally when companies with the most short interest outperform. In March 2009, the least-loved shares beat the S&P 500 by 8.1 percentage points just before American stocks posted the biggest annual increase in six years. January’s advance came as the benchmark gauge was starting a three-month, 12 percent advance.
The S&P 500 soared 13 percent in 2012, adding almost $1.9 trillion to the value of stocks in the best increase since 2009. The measure has risen within 6.7 percent of its 2007 record as the Federal Reserve tied monetary policy to unemployment and announced a third round of bond purchases, while the European Central Bank pledged to buy as many securities as needed to lower borrowing costs and preserve the euro.
The S&P 500 fell 0.3 percent to 1,461.89 today, pulling the benchmark index down from its five-year high.
U.S. shares have moved up steadily since Nov. 15, when House Speaker John Boehner reported progress in budget talks with President Barack Obama. Companies with the highest bearish bets climbed 13.8 percent on average since then compared with a 8.4 percent return in the S&P 500.
Stocks started off 2013 with a bang, as the S&P 500 climbed 4.6 percent to 1,466.47 last week, the highest since December 2007. Equities had the biggest two-day rally in a year on Dec. 31 and Jan. 2 as U.S. lawmakers agreed on a plan that averted tax increases even as Obama fell short of reaching a larger deficit-reduction bargain with Republicans. They extended gains after the Labor Department said the U.S. added 155,000 workers last month, compared with the 152,000 median estimate of 82 economists surveyed by Bloomberg.
“We’re now in a risk-on mode, which means short covering of the most-shorted stocks,” Steve Shafer, the chief investment officer at Covenant Global Investors, an Oklahoma City-based hedge fund that manages $330 million, said Jan. 2. “It’s probably a good sign because it means people expect this move to persist.”
Short sellers, who borrow securities and sell them expecting to buy them back at a cheaper price, provide only a temporary lift for benchmark gauges because abandoning their bets soaks up a pool of potential demand, said Tom Stringfellow, president of San Antonio-based Frost Investment Advisors LLC, which manages about $9 billion.
“The risk is that if this market rally has been based on short covering and that was all it was, then there’s no further money following,” Stringfellow said by phone on Jan. 2. “The rally is then either dead or not sustainable.”
Congress must agree to raise the federal debt ceiling as soon as mid-February to prevent a U.S. government default. Negotiations over the borrowing threshold in 2011 led S&P to strip the U.S. of its AAA credit rating and pushed U.S. stocks within 1 percentage point of a bear market.
At the same time, estimates of how much American companies earned in 2012 are falling. Combined S&P 500 profits were probably $103.40 a share, according to more than 10,000 forecasts compiled by Bloomberg on Dec. 31. That compares with $105.20 a share on Oct. 15. Alcoa Inc., the largest U.S. aluminum producer, is due to begin the fourth-quarter earnings-reporting season when it releases results this week.
Concern is also increasing that the Fed’s policy of asset purchases and near-zero percent interest rates that has underpinned the rally since 2009 is closer to completion than the central bank previously acknowledged. Policy makers, expressing concern over an expanding balance sheet, debated ending their bond-buying as early as this year, minutes of their Dec. 11-12 meeting released last week showed.
Bulls point to U.S. building applications and hiring that have climbed to four-year highs as reasons companies whose earnings are most sensitive to economic growth are doing the best in equity markets. Morgan Stanley’s Cyclical Index jumped 3.9 percent in December, its fifth straight monthly advance. Caterpillar Inc., which supplies machines to the construction and mining industries, paced gains with a 5.1 percent rally.
By comparison, industries less dependent on growth, known as defensives, didn’t fare as well. The S&P 500 Telecommunication Services Index, which includes AT&T Inc., fell 1.1 percent last month. A utilities measure tracking companies such as Southern Co. dropped 0.2 percent and is trading 6.3 percent below its four-year high on July 30.
“Stocks are going to go up and it’s a mistake to be too bearish here because the economic improvements are real,” Jeffrey Saut, who helps oversee about $350 billion as chief investment strategist at Raymond James & Associates in St. Petersburg, Florida, said by phone on Jan. 4. “A lot of the hedge funds were short because they were worried about Europe, the fiscal cliff and the disfunctionality of the government. But we’re overcoming these issues, so you better cover your shorts even if you get whipsawed.”
The ratio of bullish to bearish investments in U.S. equities has increased to 14.2 from a 2012 low of 11 in June, according to London-based Markit, which provides research on short sales and stock lending.
Americans missed out on almost $200 billion of gains as they drained money from stocks in the past four years. Assets in equity mutual, exchange-traded and closed-end funds rose about 85 percent to $5.6 trillion since the bull market began in March 2009 through September, trailing the S&P 500’s 94 percent surge, data compiled by Bloomberg and Morningstar Inc. show.
Expansion in U.S. housing, recovering markets in Europe and buying by individuals will push the advance in equities to its fourth and final stage, “acceptance,” Birinyi said in a telephone interview on Dec. 20. The president of Westport, Connecticut-based Birinyi Associates Inc. recommended investors buy stocks in March 2009 as the S&P 500 bottomed.
Hedge funds, largely unregulated pools of capital that can bet on falling as well as rising asset prices, are closing bets against the U.S. economy after four years of giving their clients subpar returns.
The Bloomberg Global Aggregate Hedge Fund Index, which tracks average performance in the $2.19 trillion industry, increased 1.1 percent last year. An investor who bought the Vanguard 500 Index Fund tracking the S&P 500 would have matched the index’s 13 percent return while paying fees of 0.1 percent. Hedge funds usually charge 2 percent of assets and keep 20 percent of any appreciation.
“They cannot afford to have another poor year,” said Peter Rup, the chief investment officer at New York-based Artemis Wealth Advisors LLC, which invests in hedge funds. His firm manages $600 million.
A gauge of hedge-fund bullishness, which measures how much they’re betting on rising shares, rose to 47.3 at the end of 2012 from 43.9 a year ago and is near the one-year high of 48.1 in August, according to a survey by International Strategy & Investment Group. A reading below 50 still suggests a bias toward short bets.
U.S. Steel, the country’s largest producer by volume, rose near to an eight-month high last week, helped by third-quarter earnings released in October that beat analysts’ estimates. Shares shorted in the Pittsburgh-based company reached a record of 40.6 million in June, 28 percent of the total outstanding, exchange data collected by Bloomberg show.
J.C. Penney of Plano, Texas, faces bearish bets on 29 percent of its stock. The shares fell to a more than three-year low Nov. 16 before rebounding 27 percent even as the retailer reported a third-quarter loss greater than analysts estimated. Moody’s Investors Service lowered its junk-grade credit rating three levels on Nov. 20.
“The Fed has been incredibly proactive in fighting the crisis, and has not only improved many of the economic data points but also increased consumer confidence and investors’ appetite to take on risk,” Henk Potts, who helps oversee $282 billion as an equity strategist at Barclays Plc in London, said in a phone interview on Jan. 4. “Equities will be an outstanding class in 2012 and it is understandable that investors are scaling back their short bets.”
To continue reading this article you must be a Bloomberg Professional Service Subscriber.
If you believe that you may have received this message in error please let us know.