NEW YORK (Reuters) –
Short selling of financial and automaker stocks has fallen sharply since July, as traders balk at the dimming prospects to profit from these battered shares and the U.S. government increases control over the economy.
Traders and experts expect the trend to continue, and caution that it could exacerbate volatility and weaken a key safeguard against stocks becoming overvalued.
Short selling, the practice of selling borrowed stock in hopes of buying it back at a lower price and pocketing the difference, was a popular trade in the past year, a period of extreme stress in the financial and auto industries.
But since July 10, short interest on financial companies has fallen nearly 40 percent to an average of 3.68 percent on November 14, according to Short Alert Research data released this week.
Among brokerages, the decline in short interest - the ratio of stocks sold short to overall shares - was an even greater 43.5 percent.
Short interest in automakers has declined 32 percent in the past five months to roughly 11.5 percent, with short calls on General Motors Corp (GM.N) halving since August.
"It's a greater liquidation than anything I've ever seen," said Mike Long, partner at Short Alert, who has tracked short interest for 15 years.
The decline comes as shares of these companies hit historical lows on investor concern for their financial health. Shares of Citigroup Inc (C.N) hit a 16-year low last week, while GM stock fell to its worst levels in 70 years.
Short sellers expect fewer gains are possible with share prices scraping these lows, said traders and analysts.
"It goes against conventional wisdom that short sellers pile on as stocks go to the ground," said Richard Gates, co-portfolio manager at TFS Capital.
But as stocks drop, "shorts run for the hills and take their bets off," Gates said. "I expect it to continue."
Some corporate executives have blamed short selling for driving down their companies' stock prices, as Citigroup alleged last week.
On November 20, Citigroup asked the U.S. Securities and Exchange Commission to bring back a ban on short-selling financial stocks. The request came during a week when Citigroup's stock tumbled 60 percent to $3.77, the lowest level since December 1992.
Lehman Brothers executives also blamed short sellers for their bank's demise. A few days after Lehman filed for bankruptcy, the SEC responded by imposing an emergency ban on short selling of 800 financial services sector stocks.
The effectiveness of the ban is in question - financial stocks underperformed the market for the entire duration of the ban until October 8, when it was lifted.
The recent decline in short calls, also reflected in numbers from Data Explorers Limited, suggests short sellers were not the cause of Citigroup's share slide.
Earlier this month, short calls on Citigroup were just 2.3 percent, Short Alert data shows. Data Explorers' figures indicate the number of stocks on loan - considered a proxy for short selling - was 1.8 percent last week.
Experts say traders have pared their short covers on fears that U.S. bailouts could trigger a rally in stocks that could wipe out their profits.
Further, the SEC has implemented emergency rules to crack down on so-called "naked" short selling, when traders sell short without borrowing the underlying stock, scaring off some short sellers.
"How greedy do you want to be?" said Bill Rhodes, chief investment strategist of Rhodes Analytics. "Do you want those last two to three points or do you want that thing to pop back in your face?"
Still, some investors welcome the addition of further layers of protection, saying short sellers would "get used to it," said Frederick Lipman, a securities lawyer with Philadelphia-based law firm, Blank Rome LLC.
But others lament the declining trend, arguing that if the SEC makes it harder to short stocks, the market was in danger of becoming overvalued.
"If you drive short selling out... recovery periods are much longer and more difficult, and the volume on the market is much thinner," Rhodes said. "It doesn't help stop selling."
NEW YORK – Investors held off making big moves in the stock market early Friday following enormous gains earlier in the week, as Wall Street braced for what is expected to be a weak holiday showing from retailers.
With the stock market closing three hours early at 1 p.m. EST, and many traders gone for a long holiday weekend, the session began quietly. Thin trading volume can exacerbate the market's moves, but on Friday morning, stocks traded in a narrow range.
Investors were focused on the prospects for the holiday shopping period, which began in earnest Friday. Wall Street expects retailers will suffer as consumers, nervous about lost jobs, falling home values and a jittery stock market, grow more restrained in their spending this year.
"You've seen all sorts of numbers that point to the fact that discretionary spending in the economy has come to an absolute halt," said David Reilly, director of portfolio strategy at Rydex Investments.
A rare drop in year-over-year holiday spending would be troubling as it is the most important slice of the year for most retailers and because consumer purchases account for more than two-thirds of U.S. economic activity. But while some stores around the nation appeared busy Friday morning as shoppers looked for bargains, the early evidence is anecdotal and Wall Street will have to wait for cash register tallies.
"The discounting appears to be unbelievable," said Reilly. "The retail sector is going to do whatever it can to get people through the door."
Reilly said Wall Street is likely to remain jittery as it tries to estimate how long the economy will remain weak; he is forecasting a recession of more than a year rather than the typical 10 months.
"I think the market is still in the process of adjusting to the fact that we're in a very difficult recession."
In midmorning trading, the Dow Jones industrial average fell 8.52, or 0.10 percent, to 8,718.09.
Broader stock indicators showed more sizable losses. The Standard & Poor's 500 index fell 4.91, or 0.55 percent, to 882.77, while the Nasdaq composite index declined 18.63, or 1.22 percent, to 1,513.47.
The Russell 2000 index of smaller companies fell 4.48, or 0.96 percent, to 464.42.
Because volumes remain low, the indexes' moves Friday won't likely give investors a strong sense of the market's direction. Still, it was a welcome sign that the market did not sell off strongly after the Dow's streak of four straight advances, which gave the index its biggest four-day gain since 1932.
The S&P 500 index also rose for the four consecutive days that ended Thursday, logging its largest four-day rally since 1933.
When trading began Friday, the Dow was up 8.5 percent for the week and the S&P 500 had added 11 percent.
Government bonds were little changed Friday. The yield on the benchmark 10-year Treasury note, which moves opposite its price, rose to 3 percent from 2.99 percent late Wednesday. The yield on the three-month T-bill, considered one of the safest investments, edged up to 0.04 percent from 0.03 percent Wednesday.
Citigroup Inc. was the biggest gainer in the Dow, rising 77 cents, or 11 percent, to $7.82. Just a week ago, the bank's stock was selling off precipitously, before the government put together a rescue plan for the bank last Sunday.
The dollar mostly rose against other major currencies, while gold prices fell.
Light, sweet crude fell $2.63 to $51.81 per barrel on the New York Mercantile Exchange.
Overseas, Japan's Nikkei stock average fell 0.23 percent. Stocks in India rose a day after trading was suspended because of the terrorist attacks in Mumbai, the country's financial capital. The Sensex Index ended the day with an advance of 0.7 percent.
Declining issues narrowly outpaced advancers on the New York Stock Exchange, where volume came to a light 240 million shares.
In afternoon trading, Britain's FTSE index rose 0.48 percent, Germany's DAX index fell 0.36 percent, and France's CAC-40 fell 0.27 percent.