The unusual signal screaming on our screens
Short sellers are starting to be pushed to the wall – could this become fuel for a rally? $SPY
There's a data point we've been closely following for a long time – and recently it's become very hard for us to ignore.
Short positions on various S&P 500 stocks have reached a very unusual level.
The short interest currently stands at about 3.2% of the S&P 500 index's market cap – this is the highest amount of shorts since 2009.
For comparison – at the peak of the 2008 financial crisis, the rate reached about 3.8%.
In contrast – during the 2022 bear market – it stood at only about 1.7%.
In simple terms – the market these days holds an unusual amount of bets on declines.
And it's even more interesting when looking at the stocks where short interest is concentrated:
In 10% of the stocks with the highest short interest within the S&P 500 – the rate of short positions reached about 8.0% of market cap – the highest level in about 8 years.
Even during the dot-com bubble burst in 2000 – the short interest did not reach these levels.
Why is this so interesting to us?
A short is not a symmetrical trade.
An investor who buys a stock can lose 100% of the investment.
A short seller, on the other hand, is exposed to unlimited loss if the stock starts to rise!
And when too many investors are on the same side of the boat – a small wave of gains is enough to start things moving.
A stock rises – the first short seller closes a position.
Their buying pushes the price up a bit more.
Another short seller gets nervous and closes – another buy.
The price rises further.
And so a short squeeze is created – a situation where those who bet on declines are forced to become buyers precisely when the market is rising.
In other words – short sellers themselves can become fuel for gains.
At this stage – the interesting data point is not just how many investors are short, but what will happen if they start to be wrong together.
3.2% short interest on the total market cap of the S&P 500 is a significant number,
8% in the stocks with the highest short interest is even more extreme.
If sentiment changes and investors start chasing stocks instead of fleeing them – the closing of short positions can accelerate gains far beyond what the fundamental data alone would justify.
And this is precisely where a market that seems too pessimistic can quickly turn into a very bullish market.
The bears may have arrived with plans for a collapse – the problem they will encounter – is that if the market starts to rise, they may be the ones funding the rally.