Short sellers anticipate market sell-off better than institutional investors

The large cap US stocks that have fallen the most since the August 1st have two things in common – above average short interest and above average institutional ownership. Why is this interesting? Extraordinary or “black swan” events seem to crop up rather too frequently these days and so investors want to know where to shelter when the next storm hits. With Data Explorers content now available on the Capital IQ platform (click here) we have screened for the best and worst performing names in the S&P500 and then overlaid the investor sentiment lurking in securities lending data.

Short sellers get it right

As you can see from the table, short sellers must be given credit for somewhat anticipating which names were set to fall the furthest in the mayhem the followed the US deficit debate in late July. Average short interest for the 20 biggest fallers on August 1st was 4.3% versus only 1.3% for the 20 stocks that rose the most over the period. The average across the S&P 500 Index was 2.4%.

Four of the top 10 names whose price fell by 40% or more had double digit short interest. These include Netflix (NASDAQ:NFLX), United States Steel (NYSE:X) and First Solar (NASDAQ:FSLR), with AK Steel Holding (NYSE:AKS) not far behind at 8% of the total shares out on loan. There is a degree of convertible bond arbitrage at play in some of these names alongside some heavy short selling for directional purposes.
On the flip side, did short sellers get their fingers burnt by any of those names that performed well since the August 1st? The only company with above average negative sentiment was Consolidated Edison (NYSE:ED) with 3.6% of its shares on loan. Utilities feature widely in this list of strong performers and they rarely attract any negative sentiment.

Long only managers suffered

If we look at the other side of the coin, namely the holdings of the large asset managers that lend, we see that those companies with the largest share price rises had lower institutional ownership than those firms that performed the worst. The typical US large cap security sees 25% of its shares in lending programs, so a deviation either side of this amount represents an element of overweight or underweight opinion being expressed by these large funds. The 20 stocks that rose the most since the August 1st saw only 21.4% of their shares held by these institutions. One can conclude therefore that the typical US mutual fund did not particularly anticipate which stocks would perform best during the turmoil.

But, did they avoid owning the names that fell the most in price? 24.7% was the average amount of these names owned by the funds who lend and this is only marginally below average, so the answer, I am afraid, is not really. This result is not a flash in the pan since it echoes findings we came up after assessing what happened during the huge market fall in the first week of August (). There will be more news on whether the art of buying shares with “low lendable” can form part of a quant strategy later this week.

So how are investors positioned now?

Short sellers have increased their overall short exposure to the bottom 20 firms by recent price change to 5.1% (from 4.3%). The firms with the biggest increase in such negative sentiment are both plays on decelerating global growth - AK Steel and United States Steel. 

Far from anticipating further price falls, long only funds have bought more shares in the downtrodden names compared to the names that have performed the best. This must be in expectation of a price rebound. Every politician on the planet hopes they are right!