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Short Sellers Retreat Amid Rally -- WSJ

22 Jul 2017 6:32 am

A gauge of bets against stocks is at a four-year low even as warning signs persist
By Ben Eisen and Akane Otani 

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (July 22, 2017).

Times are tough for skeptics of the bull market.

Flummoxed by the endurance of a 2017 rally that produced its 27th S&P 500 record this week, investors are backing off bets that major indexes are headed downward.

Bets against the SPDR S&P 500 exchange-traded fund, the largest ETF tracking the broad index, fell to $38.9 billion last week, the lowest level of short interest since May 2013, and remained near those levels this week, according to financial-analytics firm S3 Partners. Short sellers borrow shares and sell them, expecting to repurchase them at lower prices and collect the difference as profit.

Bearish investors say they are scaling back on these bets not because their view of the market has fundamentally changed, but because it is difficult to stick to a money-losing strategy when it seems stocks can only go up.

They believe the market moves are at odds with an economy that remains lukewarm as it enters its ninth year of growth, stock valuations that are historically high and a delay of business-friendly policies in Washington like tax cuts and infrastructure spending.

"There seems to be an overall view that people are invincible, that things will always go up, that there are no risks and no matter what goes on, no matter what foolishness is in play, people don't care," said Marc Cohodes, whose hedge fund focused on shorting stocks closed in 2008.

Mr. Cohodes is now a chicken farmer based in California who is looking to get into goat herding in Canada. He shorts a handful of individual stocks personally, but isn't focused on the broader market.

The practice of shorting companies is also going by the wayside as stocks continue to notch records. Short-biased hedge funds had $4.3 billion in assets at the end of March, down from $7.1 billion at the end of 2013, according to HFR Inc.

The difficulty for stock-market bears stems from a Goldilocks-like market environment, in which the economy is expanding fast enough to support corporate earnings, but slow enough for the Federal Reserve to keep rates relatively low. Years of low rates and easy-money policies have boosted stocks, defying forecasts for a steep, prolonged downturn.

"The shorts have been frustrated now for quite a while," said Scott Minerd, global chief investment officer at Guggenheim Partners, which has $260 billion in assets under management. The scenarios that might lead to a payout for market bears -- an economic recession or a sharp rise in interest rates -- don't seem imminent, either, Mr. Minerd added.

In one sign of capitulation among the bears, stock pullbacks have been getting shorter.

This year, there have been two times when the S&P 500 has closed down 1% or more. After these two selloffs, it has taken stocks an average of 14.5 days to recoup losses. That is well below the 25.5 days it took on average to bounce back from stretches of 1%-plus selloffs in 2016 and the 80 days it took to rebound in 2015, according to an analysis by WSJ Market Data Group.

The share of individual investors who are either bullish or bearish has also fallen in recent months, according to a weekly survey by the American Association of Individual Investors, while the share of those who are neutral has risen. As of the end of June, 43% of investors said they were neutral -- the most since last August.

"The danger is that you're too early getting out," said Ernesto Ramos, head of equities at BMO Global Asset Management, which has $246 billion under management.

The issue for investors, Mr. Ramos said, is that there remain few compelling alternatives to stocks.

Bond yields have remained stubbornly low this year, with the yield on the 10-year Treasury note ending Friday at 2.232%, down from 2.446% at the end of 2016.

Central banks around the world in recent weeks have signaled they will move toward normalizing monetary policy, nudging bond yields higher. But few investors believe inflation will pick up so much that the Fed will be pressured into lifting rates faster than it has forecast -- a scenario that could lead to sharp market losses.

At the same time, many who are invested in stocks are wary of signs that the bull market's days are numbered.

Valuations have risen to levels many investors say are stretched, with the S&P 500 trading this week at 17.86 times the next 12 months of expected earnings, according to FactSet, above its 10-year average of 14.06 times forward earnings.

Still, some who believe excesses are growing in the financial system say it is hard to convey those concerns to average investors. While signs of a housing bubble in the middle part of the last decade were abundant, indications that borrowing by companies will lead to a wave of defaults are more nuanced, said Albert Edwards, a strategist at Société Générale SA. Mr. Edwards has been bearish for most of the bull market and believes a corporate-debt binge will ultimately lead to a deeper bear market than in the 2008 financial crisis.

"It's much harder this time to see the corporate-debt excesses," he said. "It's not a headline catcher. You have to be a bit geeky to pull apart the data and analyze it."

Despite persistent concerns that investment-grade corporate bonds and junk debt are pricey, a Bank of America Merrill Lynch survey of credit investors found that none of the respondents were significantly underweight either sector.

In the week ended July 19, investors piled $4.6 billion into global equity funds, marking the eighth consecutive week of inflows for such funds, according to EPFR data.

"There's a lot of worry out there, but the market just keeps going up," Mr. Ramos said. "When everyone agrees that it's time for this bull market to keep going, that's exactly the right time for the market rally to stop."

Peter Levin and Charley Grant contributed to this article.

Write to Ben Eisen at ben.eisen@wsj.com and Akane Otani at akane.otani@wsj.com

(END) Dow Jones Newswires

July 22, 2017 02:32 ET (06:32 GMT)

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