‘No One Wants to Be Short’ Into Weekend Is Mantra Driving Bank Rally

(Bloomberg) — Friday’s staggering rally in the shares of beleaguered regional banks may have a simple explanation: short-covering.

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The $2.7 billion SPDR S&P Regional Banking ETF (ticker KRE) soared as much as 6.6% on Friday, fueled by a record surge of around 80% in PacWest Bancorp. The rebound follows several days of brutal selling and a surge in bearish positioning in regional banks, with PacWest saying this week that it’s exploring strategic options.

The driving force behind the rally may boil down to short-sellers booking profits heading into the weekend with lingering questions around what other steps regulators might take. Most recently, the Federal Deposit Insurance Corp. announced that it had accepted JPMorgan Chase & Co.’s bid for failed First Republic Bank in the early hours of Monday morning — echoing March’s weekend bombshells that the government was closing Silicon Valley Bank and Signature Bank.

With that kind of event risk in mind, combined with the fact that short sellers have likely made a tidy profit already, it makes sense to see bearish wagers roll off. Even with Friday’s surge, PacWest is still down about 40% this week.

“No one wants to be short when we’ve seen so many announcements come out over the weekend,” said Max Gokhman, head of MosaiQ Investment Strategy at Franklin Templeton Investment Solutions. “No one wants to be holding one of those names. If you’ve been short, you probably made a decent return — it makes sense to clear your books and not be caught holding something that’s going to be rescued.”

The S&P 500 has risen on six of the last seven Monday trading sessions, data compiled by Bloomberg show. While those rallies didn’t include the specific banks that were rescued, the pattern underscores the risk for bears. The benchmark index climbed about 2% on Friday, while a Goldman Sachs Group Inc. basket of the most-shorted stocks jumped 3% — its biggest rally in over a month.

Friday’s abrupt reversal comes after bearish sentiment on KRE reached extreme levels amid a roughly 40% drawdown since early March. Short interest as a percentage of shares outstanding in the ETF surged above 90% this week, from 74% a week earlier, according to data compiled by S3 Partners.

The heavy shorting in banks led to some calls this week for short-selling to be restricted — a possibility that the White House batted away on Friday. Still, that chatter combined with the magnitude of the selloff is likely spurring profit-taking among the bears, according to Miller Tabak + Co.’s Matt Maley.

“The group had become very oversold again on a technical basis and with the talk about restricting short sales that we heard yesterday, these players had no choice but to take some profits and cover their positions,” said Maley, the firm’s chief market strategist.