Short Selling Drops to Lowest Level Since Lehman

roulette wheelMy Comments: Last Tuesday, I referenced an article with a compelling reason to think the current stock market move upward would soon go the other way. The author asserted the collapse was already under way. Here is an equally compelling article that suggests it’s not going to collapse, instead is going to continue going up.  (at least for a while!)

All this is to tell you no one has a clue. After the fact, everyone on the right side of history can claim they were right. But that’s like a broken watch which is right twice every 24 hours.

In my opinion, as a fincial advisor, the solution is to employ the skills of talented money managers, people with a laser like focus on one particular component of the overall market. Then make sure they have the ability to be in the market positively or negatively, or in cash. That way you really don’t care what happens, since your chances of increasing the size of your account are higher regardless of the history.

By Miles Johnson, Hedge Fund Correspondent / July 8, 2014
Hedge funds still unwilling to bet against the rally

Hedge funds have sharply scaled back their bearish bets that the value of stocks is about to fall, with the proportion of shares earmarked for short selling at its lowest level since before the financial crisis despite warnings of renewed market exuberance.

The percentage of stocks that have been borrowed by short sellers – who try to profit from a company’s share price falling – has dropped to the lowest level in the US, UK and the rest of Europe since the years before the collapse of Lehman Brothers, according to data compiled for the Financial Times by Markit.

The fall in short selling comes as Wall Street and markets in Europe trade at near record and multiyear highs, indicating that while some high profile hedge fund managers have warned of excessive market euphoria the industry is still unwilling to bet against the rally.

The amount of so-called short interest in the benchmark US S&P 500 index is hovering around 2 per cent of total shares in the index, close to the lowest level since Markit began collecting the data in 2006. In the European Stoxx 600 index, the level is similar at just over 2 per cent, while short interest in the UK FTSE All-Share index stands at less than 1 per cent.

This compares with sharply elevated levels in the years preceding the credit crisis, with the data showing short interest in the US in 2007 hitting a high of 5.5 per cent. The Markit data does not take into account all changes in stock indices over the period.

Buoyed in part by injections of cheap money from central banks, including the Federal Reserve’s asset-purchase programme, leading stock markets have continued to rise this year after enjoying strong gains in 2013, forcing some hedge funds to cut their short bets to avoid being squeezed.

As the FTSE All-World and S&P 500 have set records, volatility has faded away, with one measure, the Vix index or “Wall Street fear gauge” dropping to a near seven-year low.

“Historically, periods of low volatility usually lead to further periods of volatility, they are not precursors to a crisis.” – Antonin Jullier, global head of equity trading strategy, Citi

This has prompted a string of recent warnings from a number of leading hedge fund managers such as Baupost’s Seth Klarman, CQS’s Michael Hintze and David Einhorn of Greenlight Capital about the distortions being caused by ultra-low interest rates and bubbles in some asset classes.

Closely-followed short sellers such as Mr Einhorn have argued that US technology shares have reached “bubble” valuations, but have bemoaned the difficulty of making bets against them given the level of hype surrounding the sector.

“It is dangerous to short stocks that have disconnected from traditional valuation methods,” Mr Einhorn told his clients earlier this year. “After all, twice a silly price is not twice as silly; it’s still just silly”.

However, despite a jittery period for some technology stocks in the first half, investors have been undeterred by the warnings, with some analysts arguing that shares are still cheap compared with other assets.

“Historically, periods of low volatility usually lead to further periods of volatility, they are not precursors to a crisis,” said Antonin Jullier, global head of equity trading strategy at Citi.

Mr Jullier said that some hedge funds had become discouraged from short selling as a result of being repeatedly wrongfooted by rising markets.

“Hedge funds have underperformed in the first half and this means their appetite for risk has fallen over the year,” he said.

Rising stock markets have coincided with sharp price increases for other asset classes, ranging from Jeff Koons’s sculptures to junk bonds and London house prices, prompting concerns among some investors that markets have lapsed back into complacency.

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