Short Sellers Back Off Bearish Stock Bets After $59 Billion Loss

(Bloomberg) — A counterintuitive trend is emerging in this volatile stock market: Short interest is declining anew as investors cash out of the market.

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Short positions have fallen by $12 billion in the third quarter for the Russell 3000 after traders incurred mark-to-market losses of about $59 billion, according to Ihor Dusaniwsky, head of predictive analytics at S3 Partners, who collated data through mid-September. That’s a 6% decline on an average short position of $986 billion.

Wild swings have been a hallmark of the stock market this year, making life difficult for bulls and bears alike even as the S&P 500 Index sank 20%. Just two weeks ago, short sellers had to endure a bruising four-day rally of 5% that forced many to cover bets that ultimately turned out sound. Already, the benchmark index has seen 79 days where at least 400 members moved in the same direction — on pace for the most in data going back 25 years.

“While short sellers did not back up their positions while they were winning, they were actively removing chips from the table when the rolls were coming up Craps,” said Dusaniwsky. He added that they’ve been reducing their exposure due to recent extreme volatility in markets thanks to the Federal Reserve.

Traders are now awaiting further clues from Fed Chair Jerome Powell. Markets are betting the Federal Open Market Committee will hike by three-quarters of a percentage point Wednesday and signal rates are heading above 4%. While a case can be made for going bigger, there’s risk that the shock of a 100-basis-point increase on Wednesday would add to recession jitters.

As to why short interest has been declining, April LaRusse, head of investment specialists at Insight Investments, says it’s difficult to be absolutely certain that markets can continue to fall.

“You’ve had a big sell off. People are like, ‘OK, well, there’s a lot of bad news already in the price. Let’s not be quite as strong in our positioning,’” she said. “That’s probably what you’re seeing there.”

Still, there are signs that beneath the surface, anxiety has been building up about blow-ups in individual companies. Appetite for protection against an index-wide drop in the S&P 500 over the next three months has been falling with the stock market, pushing the put-to-call ratio to a fresh one-year low. But data compiled by Credit Suisse’s derivatives strategists show the opposite has been happening on a single-stock level. A similar ratio jumped to a one-year high as company-specific announcements have been triggering outsize stock reactions.

“We’d be very careful taking directional bets here,” Matt Miskin, co-chief investment strategist at John Hancock Investment Management, said in an interview. “We’re just trying to find those companies that can pay us income, be more defensive in nature and minimize any downside risk.”

(Updates with context in third paragraph)