Five Years of Futility Breaking for Bears as Shorts Drop
Comment of the Day

August 11 2014

Commentary by David Fuller

Five Years of Futility Breaking for Bears as Shorts Drop

Here is the opening of this interesting article from Bloomberg which has implications for market volatility:

After a five-year bull market that has impoverished almost anyone trying to profit from falling stocks, bears are finally reaping gains.

GameStop Corp. and 3D Systems Corp. led a 7.6 percent drop last month in an index of 50 U.S. companies with thehighest short interest, the biggest retreat since 2012, according to data compiled by Goldman Sachs Group Inc. and Bloomberg. The gauge has fallen 1.7 percent this year, making money for investors who bet on declines even as the Standard & Poor’s 500 Index is up 4.8 percent.

Bearish investors are finding profitable targets in a market that had moved higher virtually in unison for two years, helped by prospects for rising interest rates and military conflicts from Ukraine to Israel and Iraq. While hedge funds wagering on stock drops have lost money almost every year since 2009, managers such as David Einhorn and Andy Redleaf are increasing bets against companies such as Athenahealth Inc. and Salesforce.com Inc.

“Stocks have started on a bearish trend and we don’t yet have signs of a bottom,” Frank James, who oversees $5.3 billion as the founder of James Investment Research Inc., said by phone on Aug. 6. “Short selling will do pretty well so long as we retain a bearish trend. It’s time to be careful.”

David Fuller's view

Wall Street is likely to be somewhat more volatile going forward, now that bear traders have re-emerged from hiding.  However, unleveraged investors have little to fear from this.  In fact, it is a healthier environment for the market. 

Markets which back and fill in a somewhat wider range than we saw from February through July of this year, prevent technically overbought conditions from reaching extreme levels.  Persistent, let alone accelerating advances over many months will alarm central bankers even more than they worry experienced investors.  Central banks will understandably fear overly leveraged market bubbles which can also trigger inflationary concerns.  If so, they will raise interest rates to curb market speculation.  Cyclical bear markets can easily follow. 

We can be reasonably certain that if the S&P 500 Index had continued to move sharply higher, the US Federal Reserve would have been under greater pressure to bring interest rate increases forward.  Persistent momentum moves have an understandable allure but they are also dangerous, as you will see by scanning long-term charts for any indices or individual instruments. 

The S&P has yet to lose its uptrend consistency.  Nevertheless, its current yield of 1.95% tells us that it has fulfilled a considerable amount of short to medium-term upside potential since January 3013.    

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