Are Hedge Funds Ruining Traditional Sentiment Readings?

I love when two articles covering the exact same topic reach directly opposed conclusions.

Typically, its not a case that one is wrong and one is right. More often, when this sort of thing happens, its because one reporter is writing the mainstream or traditional viewpoint, while the other is exploring something new.

The journalistic yin and yang this morning is on a subject we have written about frequently: Short Interest on the Nasdaq and NYSE. Bloomberg and the WSJ each have quite different takes on the subject.

Bloomberg’s coverage was straightforward — and decidely bullish:

"Ultimately you have to cover the short positions and that
tends to create more of a buying frenzy,” said Andy Engel, co-
manager of the Leuthold Core Investment Fund, which has
outperformed 99 percent of similar funds over the past five

James Paulsen, who oversees $175 billion at Wells Capital
Management in Minneapolis, expects the S&P 500 to reach 1650
this year, partly because investors betting on declines aren’t
acknowledging that stocks are cheaper relative to earnings than
in 2000 when the Internet bubble popped.

Shares of companies in the S&P 500 trade at an average 17.8
times earnings, compared with 32.8 times at the end of the last
bull market, according to data compiled by Bloomberg…

"The last time we were here there was bloody optimism
everywhere and enthusiasm about the future, and everything was
going to go up,” said Paulsen, chief investment strategist at
Minneapolis-based Wells. "Today it couldn’t be any more
opposite. It’s a pretty good environment."

Compare that with the WSJ’s Ahead of the Tape column. It takes a decidely more nuanced view on whether or not this contrary indicator still works the way it used to: 

So-called contrarians typically see such bearishness as a reason to buy. The idea is that when investors are down on stocks, expectations are so low that the slightest inkling of good news can send prices higher. In contrast, when investors get too bullish, stocks get priced for perfection, and when perfection doesn’t come, stocks decline.

But with hedge funds cutting a much bigger swath in the market, today’s high level of short interest doesn’t represent the bearishness that it did in the past. Many hedge funds engage in a strategy of offsetting the purchase of shares in one company by shorting another, betting that it will perform worse than the stock of the company that they own. Then there is the booming deals market, which drives merger arbitrage, where investors buy shares of companies set to be acquired and short the acquirers.

Because this short-selling doesn’t represent real bearishness, says Bollinger Capital Management President John Bollinger, short interest no longer says much about what the mood of the market is. "Hedge fund activity has destroyed the usefulness of the numbers," he says.

Fascinating stuff!


Short Story: Bearish Bets Lose Bullish Bias
WSJ, May 30, 2007

Short Sales Break Record on NYSE; Market Bulls Get More Bullish
Daniel Hauck and Michael Tsang
Bloomberg, May 29 2007

Print Friendly, PDF & Email

What's been said:

Discussions found on the web:
  1. Smokefoot commented on May 30

    Maybe what we need is odd-lot short selling?

  2. Barry Ritholtz commented on May 30

    Vix is broken, too. Put protection is so much cheaper in the credit markets that hedge funds are buying it there, and selling equity puts.

    Is this the sort of trade that could blow up in their faces? Perhaps, but I’m not sure how.

  3. Estragon commented on May 30

    Presumably the growth in options makes short interest less useful as well (put sellers shorting to hedge).

    Also, short interest is ancient history by the time mere mortals like us get it. Prime brokers see the order flow in real time and can act on it while it’s still news.

  4. V L commented on May 30

    “Because this short-selling doesn’t represent real bearishness, says Bollinger Capital Management President John Bollinger, short interest no longer says much about what the mood of the market is”

    It does not matter why the hedge fund managers shorting stocks (hedging or not hedging). Shorting means they are concerned about the downside; therefore, it means they are not as bullish (more bearish).

    It is bearishness no matter how WSJ spins it.

  5. Red Ocean commented on May 30

    “It does not matter why the hedge fund managers shorting stocks (hedging or not hedging). Shorting means they are concerned about the downside; therefore, it means they are not as bullish (more bearish). ”

    I am not sure that is necessarily true.

    If from a pure hedge standpoint they open large long positions and large short positions to offset those longs as a hedge their bias is basically neutral on the overall market. They are making arbitrage type of bets. Since hedge fund participation in the market has greatly increased you can make they argument that 10 years ago neither the long or short end of these positions would have been nearly as prevelent in the market. Thus there would have been far less short activity (and less long activity).

    So if you were to remove all the players who are taking short positions merely as a hedge instead of a bet on direction how would that compare to 10 years ago? I don’t know that answer to that.

    Its also the case that these shorts probably don’t create quite the pent up upside presure or floor under the market that a true short bet would. If someone is truly naked short and the market goes against them they need to cover eventually before their liquidity dries up. But if you have a neutral bias with both long and short the gains in the longs make up for the losses in the shorts.

    If for some reason they decide to close out their positions they buy back the shorts, sell the longs and create offsetting pressure on the market that is still basically neutral.

  6. BDG123 commented on May 30

    Barry’s take on this is appropriate. There are MANY strategies that involve shorting shares that doesn’t necessarily imply significant risk of being yanked out of a position by rising markets. To the contrary, many may profit from rising markets.

    Btw, long/short strategies do not have to be bearish. I might be long large caps and short small caps and only care to capture the spread. That way I make money regardless of the market’s direction with a bent towards higher risks in the American economy or higher risks towards a correction.

    I could even be long/short two companies within the same industry to reduce the risk. Depending on the potential for gain in either direction, I could be long or short the leaders or laggards. All I want is spread expansion. Spreads have been around a long time and more sophisticated investors are likely utilizing them more in equity markets.

    High short interest in the equity markets means nothing if it is not dumb money or if it is being used to mitigate risk. It’s a single variable and only dunces use single variable analysis.

    How about another perspective. The bulls may be wrong and high short interest might be very smart money mitigating risk? How about that as a contrarian view on a contrary indicator. Two wrongs may make a right.

  7. S commented on May 30

    VL – that’s not always true.

    As I pointed out the last time Barry brought up the short interest numbers, hedge funds are pursuing risk arb, statistical arb, convert arb, capital structure arb, long/short, stub trading, and spins as market neutral, non-directional strategies. Each trade involves a short leg as part of the strategy. If you’re a hedge fund who has promised your investors that you will deploy capital using only market neutral, non-directional strateiges, you can’t suddenly take a directional bias.

    I guess you could, but if things go wrong, you might be sued or wearing stripes.

  8. V L commented on May 30

    Red Ocean,

    I agree, it could mean as “neutral” but to make this conclusions you are making assumptions that the increase is secondary to the hedge fund hedging by shorting stocks (rather than simply buying puts).

    In other words, one would need to show that the hedge funds are changing their hedging practices from buying puts to shorting stocks. This practice makes no sense if you are bullish – by shorting stocks you freeze more capital (you freeze more funds by shorting vs. buying puts)

    I have not seen such evidence (maybe you have); therefore making assumptions that the high short interest is secondary to hedge funds hedging is wishful thinking.
    Why do we have to make the assumptions and come up with so complicated exotic explanations (different from what it simply means) for high short interest?
    Is it different this time and high short interest means bullishness this time? Is it different this time?

  9. V L commented on May 30

    “Btw, long/short strategies do not have to be bearish. I might be long large caps and short small caps and only care to capture the spread.”


    We are talking about the change in short interest (meaning it is not the same as it used to be, it has increased). Bullish to neutral means more bearish not more bullish.

    In other words, it means they were not “short small caps” before but they are “short small caps” now; hence the increase in short interest (increase in bearishness, not bullishness as WSJ spinning it).

  10. V L commented on May 30

    In other words, I am not saying that the sentiment has changed from bullish to bearish.

    I am saying it has changed from extremely bullish to less bullish or neutral, the sentiment is more bearish now than it used to be (not more bullish as WSJ spinning it)

  11. Byno commented on May 30

    Have fun trying to use short interest as an indicator of any kind. Like AAII bullish percentage levels, Market Vane sentiment indicators, McClellan Oscillators, etc ad nauseum, the predictive value of short interest is approximately zero at the 95% confidence level.

    “Yeah, but it worked during [insert cherry-picked time frame here].”

    Fan-fucking-tastic. Let’s ignore that short interest spiked in January of 04 right at the intermediate top, only to spike again in the summer of 05 at a bottom.

    I love Barry’s site. He’s like Letterman in that, even on his off days, his material is still miles ahead of most.

    However, I’ve had my fill of these sentiment indicators. Show me me an indicator that is “too high” or “too low” for something to happen and I’ll let you ride shotgun in my WayBack machine on our trip to a place where the same variables were in play and the thing that couldn’t happen did.

    Short interest is high. So what. It was almost nonexistent at the October ’02 lows. Does that mean we shouldn’t have bought because not enough people were short?

  12. donna commented on May 30

    We used to use the markets to invest in growing companies. Now it’s all just a game.

    Sad, really. I miss America. I miss our actually being able to make things, instead of just playing around with money while the working people get shafted.

    Oh well.

  13. AE commented on May 30

    instead of just playing around with money while the working people get shafted.

    Donna, you should check the ‘largest shareholders’ field on any of the stocks in the S&P. 70% of Americans own 401(ks) which are deeply invested in the ‘game’ of stock selection.

  14. tt commented on May 30

    Hey Donna ,

    We make Fords and Chevys , what does that tell you…….

  15. SBG commented on May 30

    Merger Arb would make sense with all the M&A activity. But who do you short when the acquired is purchased by Carlyle, KKR, or TPG?

  16. michael schumacher commented on May 30


    You don’t

    All the hype that surrounds some private equity deal that is used to push the market up makes me laugh since none of us here can participate in it….. why should it matter to the stocks that we can trade?? The simple answer is that it does’nt… is used as bait to get the retail ball rolling, once it gets going it’s a tad hard to stop it even if it’s BS or not….

    It’s going to be a long summer……


  17. Fred commented on May 30

    I’d be curious to see the current numbers combining the Rydex Short ratio with the use of Pro Source Inverse ETF’s. This would givce a “cleaner” picture of individual investors wishing to specifically short stocks. They are not (typically) used in neutral strategies.

  18. John commented on May 30


    Those 401(k) plans ar only adjustable every six weeks. Yet they’re contributed to with every paycheck.

    I can quite assure you, it isn’t the 401(k) holders who are going to wind up with all the Bernanke Bucks when the music stops. No, it’s going to be the same folks who’ve been the beneficiaries of the “Temporary Open Market Activities” every day for the past three months: the internal hedge funds of all the big brokerages, as well as all the FOBs (friends of Bushie).

    Have you not noticed the rally getting narrower and narrower? Have you not seen that we run up on relatively light volume, have a big sell-off day with a voulme spike, then return to the low-volume rise? It works like this: The Money Boyz put a floor under the market, not really bidding it up much but simply refusing to let it go down. Then they juice it suddenly to the upside, to squeeze the shorts (who persist in serial top-calling), which causes a big albeit lower-volume uptick. The “outsiders” come running into the uptick and the insiders not only sell what they bought to start the squeeze, but some of their existing inventory, as well. Once the outsiders dry up, the whole process repeats, until the markets have moved up another “level” (so to speak). Then we get a sell-off day again, down to the top of the last “level,” which causes all the shorts to reload. Then the buying floor is put into place again, and the whole mess repeats.

    The wretched part is that there is absolutely no way of knowing when this obscene, government-sanctioned (hell, government-FACILITATED!) manipulation will end. So if you wanna ride that train, be my guest. Just remember, there is a tressel coming up that runs out of track halfway across its river, and the train is moving so fast that unless you’ve got the eyes of an eagle you aren’t going to see it coming until it’s too late to jump off…

  19. Barry Ritholtz commented on May 30


    Note the distribution curve of the 70% of Americans who own 401(k)s — for most of them, it is a near after thought. Their net wealth is primarily in their homes, which is why the stock market wealth effect (or this rally) matters less and the housing market correction matters more to them.

    The distribution of assets is dominated by the top 10%, which is dominated by the top 1%, which is in turn dominated by the top 0.1%.

    I always find the 70% number impressive — until I remember that 90% of the country has a relatively tiny stake in equities . . .

  20. John commented on May 30

    Fed minutes: Inflation still too high, housing not bottoming, growth nothing special. No cut, no hike—the Fed is Fucked. Sell program at 2p on the dot to suck in the shorts, then the predictable spike back up (with whipsaw goodness) to pick their pockets.

    In other words, same old, same old.

  21. Fred commented on May 30

    Whenever “smart” cynics can’t read the water well, they claim a conspiracy theory. It’s like clockwork.

  22. John commented on May 30


    Keep dancing. I’m going to laugh my ass off at all of you smirking bulls when the shit finally hits the fan, because you’re all going to get crushed.

    And BTW, it can’t be a conspiracy if it’s being done in broad daylight, now can it? So no, it’s not a conspiracy; it’s a chosen, blatant course of action predicated upon the public being too dumb to know what’s up, the business press being unwilling to tell the truth (aside from the occasional mutter), the SEC being a bad joke, and the politicians being entirely bought and paid for.

  23. Estragon commented on May 30

    Fred – I think there’s some truth to that, although I don’t think it’s restricted to us cynics. If markets were being going down “for no reason”, there’d no doubt be “smart” bulls screaming conspiracy.

  24. S commented on May 30

    Breadth running 2:1 positive on good volume?

  25. Fred commented on May 30

    Tickersense Blogger Poll:

    Bullish = 25%

    Bearish = 46.88%

    Neutral = 28.13%


  26. Steve commented on May 30


  27. Marc commented on May 30

    Screaming “squeeze” shows that you haven’t been squeezed before. AMZN was a short squeeze. This isn’t a short squeeze…

  28. Shrek commented on May 30

    Barry makes a great point about stocks and the general public. News about the economy isn’t great, but the stock market doesn’t reflect most Americans. The rub for the whole world is the American consumer. If there is truly slowing, which I think there is, then almost everyone is wrong about asset prices. The ROW is literally throwing credit at people and they simply cannot take on more debt. Thats why imbalances do matter and we are at the tail end of this game. Where are the other major consumers outside the US? Nowhere. Our spending is still a massive part of global gdp.

  29. Carl commented on May 30

    Barry, you more than anyone else knows that even the large published macro data such as NFP & Home Sales are incredibly inaccurate.

    With this in mind, how could Bollinger dissect the published short interest numbers to a level where he knew what short interest belongs to bears and what belongs to hedge funds laying off risk?

    If he has built some software algorithms that can quantify this, he will be on the Forbes list very soon. If not, he’s just tongue wagging.

  30. V L commented on May 31

    No more tail wagging the dog B.S.!

    The U.S. stock market is the top dog, not the Asian wannabe nonsense.

  31. mp commented on May 31

    The only reason Little America is in 401Ks is because there aren’t any pensions any more.

Posted Under