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Short interest rises along with markets


Someone is going to be significantly wrong


Our contacts told us the rally off the August lows, at least in biotech, was triggered by technicals and extended by short covering. A glance at the overall short interest levels for the NYSE and the NASDAQ seem to contradict that view. Not only did the indices rise nicely mid-August to mid-September, short interest rose as well. NYSE short interest climbed about a percentage point. NASDAQ short interest climbed 1.8%

In the 22 companies our firm covers, short interest rose significantly in about half and declined slightly in the other half. Not much insight there, unfortunately, though it does explain some of the flickers on my screens in the last month.

A glance at short interest in the Biotech Holder (AMEX:BBH, an imperfect proxy for the BTK) shows short interest rose 8.84% in the last month. A glance at the NASDAQ Biotech Index iShare (AMEX:IBB, a much better proxy for biotech) shows it rose 7.96%. I must note that the short interest on the IBB was up 42.61% in the month of August. I suspect both of these measures are imperfect (or, more likely, unreliable) indicators of short interest in the sector as they are obviously used as hedges more than primary plays.

That brings up an interesting point: Sentiment surveys and the VIX show a marked degree of complacency and bullishness. This is in direct contrast to the consistent rise in short interest we've seen since January 2003. One could surmise this means the short interest figures are of no prognostic value. Perhaps. As Todd often notes, however, it is one of many metrics.

One alternative view is it could provide one explanation for why the markets are not flying rapidly higher despite widespread bullish views. Professor Reynolds continues to note the disconnect between bond spreads and equities. Perhaps increasing short interest has something (though obviously not everything) to do with that phenomenon.

I wish I could give you some definitive conclusion based upon these data. I think we're all looking for something, anything definitive in this herky-jerky market. I'm afraid the best I can do is pile on yet one more "metric" to keep in the back of our already crowded heads.

My gut tells me this rise in short interest is as unsustainable as NASDAQ 5000. What it doesn't tell me is at what point the card house will need to get before it collapses under its own weight.

No positions in stocks mentioned.

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