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Short Interest Dives


Taking profits when markets drop is NOT a lack of conviction


NYSE short interest for the period between mid-January and mid-February decreased 5.24%. It was down about 730 million shares from the 8.8B record shares short set in November. The value of the NYSE composite index dropped about 1% during the same period. NASDAQ short interest also dropped, though not as much at only a 1.45% decline. NASDAQ short interest is off about 110M shares from its most recent record last October. The NASDAQ Composite was down 1.19% during the same period.

Short interest dropping when the market retreats is opposite of what some might expect. When the opposite happens to longs in a rising market, comments about non-confirmation of the trend are legion. As readers of the Buzz are well aware, there are plenty of measures to be found that do not confirm recent market moves. Non-confirmation from the long side plus non-confirmation from the short side – perhaps that means more sideways action in the market as a whole. Profiting in such a landscape requires better stock picking and the ability to follow relatively rapid sector rotations.

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).

Short interest versus composite indexes

The 160 biotech stocks on the NASDAQ Biotech Index (NBI) index saw their short interest drop 4.51% both on the total number and on average. The NBI gained about 1% during the same period. Short interest of the NBI as a percentage of overall NASDAQ short interest is now at 12.35%.

NBI short interest declined about 32.4M shares, an amount mostly made up of declines in three stocks: Amgen's (AMGN) drop of 9.7M, BiogenIdec's (BIIB) drop of 3M, and Teva's (TEVA) 20M drop. I don't want to give the impression this 4.5% drop wasn't widespread. It was. Most stocks saw their short interest go down. These three, however, were unusually influential in the overall measure.

Short interest in the IBB, the iShare ETF for the NBI, gained 1.62% on top of last month's 23.94% change. The BBH, a HOLDr ETF approximating the AMEX Biotech Index (BTK), saw short interest drop 5.2%, the eighth drop in the last 12 months.

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. 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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No positions in stocks mentioned.

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