Shorts Fall Short

This morning I received the following article from the Wall Street Journal.

Even a 5% pullback in stocks hasn’t provided enough fuel for short sellers to start betting against the market again.

Short interest, or bearish bets, on S&P 500 stocks fell to 2.3% of shares outstanding at the end of last week, the lowest level in six years, according to data securities-financing tracker Markit. Short sellers borrow shares to sell them in hopes of buying them back at a later date, aiming to profit from price declines.

The fact that short interest has yet to pick up, even amid the market’s biggest selloff of the year, shows how the skeptics aren’t convinced stock prices will keep falling, even as volatility has picked up, bond yields have jumped and overseas markets have tumbled.

“The shorts have been beaten down for so long that they might be more hesitant to get into the way of this thing,” Bill Stone, chief investment strategist at PNC Asset Management Group, which has $119 billion in assets under management, told MoneyBeat.

The S&P 500 has fallen 5.8% from last month’s record high, suffering its first pullback of greater than 5% since November.

Daily gyrations of more than 1% apiece have become the new norm ever since Fed Chairman Ben Bernanke hinted last month that the Fed could start pulling back on its bond-buying program within the next few meetings. He elaborated last week, saying the central bank could start winding down its stimulus measures later this year and end them all together by mid-2014.

And yet yesterday’s intraday action explains exactly why the shorts are still spooked by this market. The Dow tumbled as many as 248 points early in the day as bond yields surged amid concerns about future Fed policy. But the blue-chip average bounced sharply and by mid-afternoon, it was down less than 50 points after Dallas Fed President Richard Fisher said the QE exit strategy is still way out in the future.

The Dow finished down 139 points, illustrating how sharply these markets can move on any whiff of Fed policy.

Jeffrey Kleintop, chief market strategist at LPL Financial, which has $375 billion under management, said he expects volatility to continue as investors prepare for the Fed to wind down its bond-buying program. “However, the knee-jerk reaction of selling across all markets – stocks, bonds and commodities – is unlikely to persist,” he says, while advocating investors to buy the dips.

The suggestion that selling across the board isn’t a sustainable phenomenon is exactly what’s keeping the shorts on the sidelines, even amid the market’s biggest decline of the year. The thought that stocks could bounce back sharply at any time is what’s making them worried about betting against the market right now.

“Anytime there’s been a selloff, you’ve seen a vicious rebound,” PNC’s Stone said. “It’s the once-bitten, twice-shy routine for short sellers.”

Source: Morning MoneyBeat

This news is actually a big concern for me because, if truly accurate, it means that the recent declines in stock prices have been driven by investors exiting the stock market, rather than by short sellers artificially driving prices down. Though the declines can provide perfect buying opportunities for bargain hunters, no on can know at what point short sellers will jump in with any conviction. This could be a tremendous concern for those who may be entering, or already in, their retirement years, because no one can know with any certainty at what levels prices will fall and/or at what levels prices will stabilize once the declines abate.

This will be one to watch carefully.

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