Rough Week for Shorts as Banks Send S&P 500 to Four-Month High

  • Goldman Sachs Index of most shorted in best week since March 4
  • Financials lead S&P 500 groups after earnings beat estimate

In an already brutal two months for short sellers, this week was one of the hardest.

Despite the start of what will probably be the worst earnings season in seven years, advances in bank stocks, energy companies and industrials sent the Standard & Poor’s 500 Index to its highest level in four months. By mid-week, investors began to snap up companies whose prospects are tied to an expanding economy, leaving behind defensive shares that had been the market’s most consistent winners.

Rallies keep coming in a market awash in skepticism, with short interest near all-time highs as valuations sit well above their five-year average. Better-than-expected earnings, particularly among banks, and a rally in commodities boosted a Goldman Sachs index of the 50 most shorted equities to its biggest increase in six weeks, burning short-sellers who speculated they would fall.

“When you go into an earnings season where there’s a lot of short interest, it very often portends to an up market because you always get the positive surprise,” said Quincy Krosby, a market strategist at Prudential Financial Inc., which oversees about $1.2 trillion. “JPMorgan was greeted with a positive move, and then shorts have to cover their positions. It gives the market a bounce.”

The S&P 500 advanced 1.6 percent to finish the week at 2,080.73, and closed Thursday at the highest level since Dec. 4. It’s rallied 14 percent since falling to a 22-month low on Feb. 11, and is now 2.4 percent below its all-time high in May. Crude traded above $40 a barrel amid a 1.6 percent weekly gain as it extends a rally from a 12-year low. The Dow Jones Industrial Average gained 320.50 points, or 1.8 percent, to 17,897.46, the best week since the five-day stretch ending March 18. The gauge touched the highest since July.

As earnings season got into full swing, analysts predict that net income would plunge 10 percent -- the worst performance since the aftermath of the financial crisis. That was raised to a 9.5 percent drop Friday. Banks, plagued by energy exposure and negative rates from central banks, are expected to bear the brunt. The group as recently as August was predicted to see a 2.8 percent gain in first-quarter income. That fell to a 12 percent decline heading into the reporting period.

While profit did contract at JPMorgan Chase & Co., Citigroup Inc., and Bank of America Corp., shares in all three climbed at least 7 percent after they announced reductions in first-quarter expenses that beat analysts’ estimates. Those results lifted U.S. equities, particularly financials, which rallied 4 percent for the best weekly gain since March 4. People’s United Financial Inc. and Zions Bancorp also surged. The two had 16 percent and 6 percent, respectively, of shares outstanding borrowed for short selling, data compiled by Markit Ltd. show.

“Earnings are off to a very healthy start, financials set a positive tone,” said Joe “JJ” Kinahan, chief strategist at TD Ameritrade Holding Corp. “For the market to rally, financials have to be performing and financials performed this week.”

Pessimism remains as a six-week rally for U.S. stocks sparked by central-bank promises of support and rising crude led to a surge in short interest, with investors speculating the gains had gone too far, too quickly. Bets against S&P 500 equities averaged 4.2 percent of shares available as of March 31, 15 percent above the seven-year average, according to exchange data compiled by Bloomberg. The level touched 4.4 percent at the end of February, the highest since 2008.

Those positions didn’t pay off this week. Energy-related companies in the S&P 500, whose short interest of 5.8 percent of shares available is the highest, jumped 2 percent and closed Thursday at the highest since Dec. 2. Southwestern Energy Co., the second most shorted stock in the S&P 500, surged 21 percent, while Chesapeake Energy Corp. jumped 60 percent. Raw-material companies, the third-most shorted industry, rose 3.1 percent to their highest level since Aug. 10.

There were also signs that concerns of recession had all but evaporated. Industries which investors flock to in times of economic turmoil were the only to fall this week. Consumer staples and phone companies dropped 0.8 percent and 0.5 percent respectively, for the only declines among 10 groups. Meanwhile, riskier shares saw gains. The S&P 500 High Beta Index, which tracks stocks most sensitive to market swings, gained 5 percent, its most in six weeks.

“We have to stick with the same recipe that has been working these past nine weeks, which most importantly has been broad participation. One thing we hadn’t seen up to this point was interest in defensive areas wane,” Frank Cappelleri, executive director at Instinet LLC in New York, said by phone. “It will be interesting to see if this is just a one-week event, or if this move can extend longer and move the market to eventual highs.”

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