Behind the correction of U.S. stocks lies a fierce game: the level of short bets hits a record

Behind the correction of U.S. stocks lies a fierce game: the level of short bets hits a record.

The latest statistics show that short bets on the U.S. stock market have soared to the highest level since statistics began. This may be part of the reason why technology bull stocks have pulled back recently.

According to data collected by S3 Partners since 2010, short positions in S&P 500 stocks as a percentage of free float are currently approaching 3.79%, just one step away from the highest level in history. At the same time, the proportion of short shares in the Russell 3000 Index recently rose to 6.3%, which has set a record.

Data from Goldman Sachs also shows that the short position of the median S&P 500 component has reached 3% of its market capitalization, the highest level since late 2011. Overall short positions in the S&P 500 have grown nearly 10% in the past three months and now stand at about 1.4 billion shares.

As background, when short sellers borrow shares and sell them, they expect the stock price to fall so that they can buy them back at a lower cost to close their position. In the first six months of this year, shorting U.S. stocks was basically a money-losing business.

But as talk of AI-related capital spending heats up, bears appear to have found a reason to hang on. Data compiled by Reynolds Strategy also show that short positions in New York Stock Exchange-listed stocks have continued to increase since February this year and reached a record high of 9% of the total outstanding shares at the end of June.

This compares to about 5% during the 2008 global financial crisis and 6% during the COVID-19 pandemic. "Short positions have grown almost vertically recently," said Brian Reynolds, the firm's chief market strategist. But Reynolds also believes that rising bearish sentiment is likely to be offset by investors continuing to buy stocks.

These two opposing forces have caused the stock market to basically fluctuate sideways in the past month. At the same time, it has also digested part of the previously accumulated speculative bubble, creating conditions for subsequent rises.

"We continue to believe retail investors will continue to drive stocks to new highs going forward, while corporate buybacks will accelerate during market declines, helping stock prices rebound from their lows," he said in a note to clients last week.

While most of the short bets have yet to pay off, some stocks that have been concentratedly shorted have delivered handsome returns. For example, Hertz Car Rental's stock price has plummeted 65% this year, and about 79% of its outstanding shares have been short-sold by investors.

Another case is SpaceX, which has just been listed and has a relatively small number of outstanding shares. According to S3 data, SpaceX was the ninth most shorted stock in the U.S. market before its stock price fell last Friday, with the amount of short bets reaching $25 billion, accounting for nearly 29% of its outstanding shares.

The SpaceX short position has generated gains of about 28% on a market-to-market basis, equivalent to a paper profit of $4.8 billion. The large number of short positions that have reached a record high not only reflects investors' concerns about future trends, but also poses a potential "short squeeze" risk.

If the market continues to rise, these borrowed shares will turn into an increasingly expensive liability that could eventually force short sellers to buy back shares to cover their positions. In the event of a short "push", buying pressure will further push the price higher, forcing more short covering, which will push the price higher again.

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