- Short interest rises on both NYSE and Nasdaq, likely to rise more near-term
- Short squeeze big factor behind rally post-Oct 15th trough; bulls unable to force another
- Short interest on IWM drops 46% in five months, even as ETF manages to rally tiny five percent
Short interest rose nearly two percent in the latest period (as of January 15) on both the NYSE composite and Nasdaq composite. Odds are rising that shorts will continue to press their case at least in the near term.
The December-end to mid-January period was one that saw stocks come under some pressure. Prior to that, from the mid-October lows to the end of December, short interest had fallen by a good amount – by nearly 10 percent on the Nasdaq and five-percent-plus on the NYSE. Shorts got squeezed. Plain and simple.
Short interest can rise for a variety of reasons. It can sometimes get distorted by arbitrage transactions. On the NYSE, for example, specialists may have to fill demand by shorting out of their own accounts. But all in all it is a good data point to use as a secondary indicator.
A high level of short interest leaves room wide open for a potential squeeze. Historically speaking, short interest remains high currently (Chart 1 and 2), though nowhere near what it was in the middle of 2008. But the thing is, just because short interest is high does not mean a squeeze is coming.
Bulls did a great job of squeezing shorts in the wake of that mid-October low. But now it looks like they are running out of bullets.
There is a change in the tone of the market. It increasingly feels like bulls are struggling to attract new sources of funds. Rallies get sold, or are difficult to hold. Daily swings are way too volatile. There is indecision in the air. Short interest is high, but if bulls cannot force a squeeze, it is their loss – not being able to climb a wall of worry.
In this scenario, bears will begin to smell blood. Barring a few, 4Q earnings so far have not been that impressive. The Eurozone QE bounce has been quickly lost. Day in and day out, Greece is in the headlines. And the past few days, there has been an increase in voices calling for postponement of the Fed’s rate-hike plans until next year.
As far as bears are concerned, uncertainty can act as opportunity.
IWM, for example, is a classic case of bulls not being able to build on momentum that came their way. Late last year, the ETF even managed to break out of a multi-month range, but small-cap bulls were not able to hang on to it. In fact, increasingly it looks as though smart money was getting out even as the ETF was staging a breakout. Short interest at the end of July last year was 172.5mn. By the end of December, it had dropped 46 percent. The ETF rose five-plus percent during the time. That is it. All that short-covering was good for a mid-single-digit-percent gain. This probably is setting up perfectly for those green bars to spike higher.
