How did US short sellers react in the third quarter?

Hot on the heels of what can easily be described as the most turbulent quarter since the height of the credit crunch, US hedge funds are aligning their strategies by increasing their short bets on aggregate and switching their focus to sectors they believe are likely to be affected by the shifting situation. A recent Financial Times article encapsulated the negative outlook of many macroeconomic hedge fund managers. We use securities lending flow to assess which sectors across the S&P 500 have been impacted the most and least over the past quarter. In summary, we see the Semiconductors, Commercial & Professional Services and Food & Staples sectors have been subject to the most negative sentiment while the Pharmaceutical, Food & Beverage and Household & Personal Products sectors have been the least affected. Only the latter saw positive investor sentiment in this period.

Short interest in the S&P 500 stands at 3.13% of the total market capitalization - an increase of 22% since the start of the third quarter, mostly coming from a steady rise in August. Of the sectors which make up the Index, the Semiconductors sector is the most shorted with 6.1% of shares out on loan, followed by the Commercial & Professional Services and Food & Staples Retailing sectors, with short interest at 5.8% and 5.2% respectively. It is worth noting that Food & Staples Retailing is skewed heavily by a high 25% short interest in Supervalu Inc, (NYSE:SVU) without which the sector would have a below average short interest of 2.6%.

Looking at changes in short interest over the quarter, the Transportation sector recorded the largest increase of 83%, with the percentage of shares on loan having jumped to 1.6% from 0.9%, although it still remains the third least shorted sector in the index. Other sectors with large increases in short interest include the Material sector with a 67% increase to 4.2% of shares shorted on average and Automobiles & Components with an increase of almost 60% to 3% of the total market cap.

Of all 24 GICS level 2 sectors which make up the S&P 500, only one sector, Household & Personal Products saw a decrease in short interest, recording a 5% drop in shares out on loan to 1.45% of the total capitalization. This also makes it the least shorted sector. The companies which make up the sector focus on basic consumer needs, including bleach producer Clorox (NYSE:CLX), consumer goods maker Colgate Palmolive (NYSE:CL) and fast moving Consumer Good giant Procter and Gamble (NYSE:PG). These shares are typically referred to as non-cyclical for their ability to outperform the market in the event of an economic downturn – and that is what investors are clearly hoping.

Other sectors which recorded relatively low levels of short interest include Pharmaceuticals and the Food, Beverage & Tobacco sectors with 1.5% and 1.7% of their respective market cap. out on loan. Both of these also focus on consumer needs rather than discretionary wants.

Bottom line

The market turmoil in August marked a wake-up call for short sellers in the US as they reacted to the macro-economic challenges. A review of the quarter highlighted that US short sellers have steadily increased their bets as the economic outlook deteriorated, yet they have been selective in avoiding sectors which are insulated from the worst of the economic headwinds.