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Short Interest Drops


I like Santa, I just don't like his rally


NYSE short interest for the period between mid-November and mid-December decreased 3.48% from a new record high set in the previous period. The value of the NYSE composite index increased 3.66% during the same period. NASDAQ short interest also went down slightly, off 0.53% in the second drop in as many months. The NASDAQ Composite was up 3.38% during the same period.

The graph I've been using appears below. It uses January 2003 as an index year (for no reason than that was a complete year bull market and the first year where I collected data. I'm not certain the graph is anything more than informational, but I think it is worth pointing out the pattern of the indexed NADSAQ Comp (in dark blue) after each time it was eclipsed by the indexed value of the NASDAQ short interest (light blue).

Biotech generally followed along, though data for this time period is particularly noisy because of the NASDAQ Biotech Index (NBI) index rebalance. Short interest as measured for the entire NBI was up 2.34%, though that is almost certainly due to the addition of several new stocks. Average short interest on the NBI was down 3.48%, outpacing the overall decline in NASDAQ short interest. The NBI gain 0.48% during the same period.

Short interest of the NBI as a percentage of overall NASDAQ short interest is now at 12.53%, the highest it has ever been. The rebalance is likely skewing this figure, though I note the data set contains three other rebalances and this number is still higher.

Short interest in the IBB, the iShare ETF for the NBI, dropped by 19.36%. This is the second monthly drop in a row after the big bearish biotech bet put on in October. The BBH, a HOLDr ETF approximating the AMEX Biotech Index (BTK), saw short interest drop a little over thirteen percent for the second month in a row.

As I did last year, I re-sorted the data set to examine the pattern of short interest for 2005. The chart below examines the relationship between NYSE and NASDAQ short interest and the composites just as the one above does, but the data are indexed on January 2005.

The graph is merely a pictoral representation of what anyone who has been watching the short interest story unfold in 2005 already knows: The increase in short interest outpaced the movement of the major averages.

The NYSE tracked closest, with the increase in the composite value outpacing the increase in short interest by a hair.

The value of the NASDAQ composite closed the gap some over the last two months of the year, but is barely within hailing distance of the increase of NASDAQ short interest. This is the second year in a row short interest on the NASDAQ has increased at a greater rate than the composite value. The composite's outperformance on the first graph is driven almost entirely by the 2003 data.

It is often argued in these pages paying attention to short interest is futile. I'm guessing the theory is all these positions are hedged (I'm sure I'll be corrected if I mis-state the theory). With the rise in zero-volatility funds, I'm guessing there is some truth to this point of view.

However, short positions and their hedges carry an expense. Dividend payouts, borrowing premiums, margin rates, and derivative costs all make a dent in the P&L. I still maintain this short bubble will matter at some point. I've admitted the rise in short interest will not cause a rally, only accelerate one already underway.

Therefore, short interest is like most of the macro concepts discussed around here (high debt, low savings, Fed liquidity, etc.). Not immediately actionable, but very worthwhile to keep in the back of your mind as a factor in your risk analysis.

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