Bloomberg News

Five Years of Futility Breaking for Bears as Shorts Drop

August 11, 2014

After a five-year bull market that has impoverished almost anyone trying to profit from falling stocks, bears are finally reaping gains.

GameStop Corp. and 3D Systems Corp. led a 7.6 percent drop last month in an index of 50 U.S. companies with the highest short interest, the biggest retreat since 2012, according to data compiled by Goldman Sachs Group Inc. and Bloomberg. The gauge has fallen 1.7 percent this year, making money for investors who bet on declines even as the Standard & Poor’s 500 Index is up 4.8 percent.

Bearish investors are finding profitable targets in a market that had moved higher virtually in unison for two years, helped by prospects for rising interest rates and military conflicts from Ukraine to Israel and Iraq. While hedge funds wagering on stock drops have lost money almost every year since 2009, managers such as David Einhorn and Andy Redleaf are increasing bets against companies such as Athenahealth Inc. and Salesforce.com Inc.

“Stocks have started on a bearish trend and we don’t yet have signs of a bottom,” Frank James, who oversees $5.3 billion as the founder of James Investment Research Inc., said by phone on Aug. 6. “Short selling will do pretty well so long as we retain a bearish trend. It’s time to be careful.”

James Investment Research is studying utilities, technology providers and raw-materials companies for short sales, in which a bearish trader sells borrowed shares in the hope of replacing them at a lower price. The James Advantage Long-Short Fund (JAZZX:US) in Alpha, Ohio, is up 5 percent this year, beating 81 percent of its peers tracked by Bloomberg.

Weekly Return

The S&P 500 added 0.3 percent last week, recovering from its worst weekly decline since 2012, as signs that tensions are easing in Ukraine outweighed concern over crises in the Middle East. Data on U.S. services and factory orders fueled speculation that the Federal Reserve may raise interest rates sooner than investors anticipate. The index rose 0.3 percent at 4 p.m. in New York.

The benchmark gauge for American equity has gone almost three years without a decline of 10 percent or more and 460 of its constituents rose last year, the most since at least 1990. Since reaching a record 1,987.98 two weeks ago, the index is down 2.8 percent.

Bearish Bets

Almost 4 percent of American stocks had been borrowed and sold as of July 15, the most in two years, according to exchange data compiled by Bloomberg. GameStop, the Grapevine, Texas-based video-game retailer, had the most bearish bets among S&P 500 companies. The stock has plunged 12 percent in the last nine trading days.

3D Systems, the Rock Hill, South Carolina-based maker of three-dimensional printers, has tumbled 24 percent since July 1. Bearish bets on GameStop and 3D Systems accounted for about 30 percent of shares.

More than 170 companies in the S&P 500 are down this year, versus 48 at this time in 2013 and 125 in 2012, data compiled by Bloomberg show. Two of the 10 industries in the benchmark index have posted losses and three others have advanced less than 2.5 percent, compared with this time last year when the worst-performing group had rallied 7.1 percent.

“You were seeing the winners win and the losers lose so we actually thought that this could be a really good year for shorting,” Mark Yusko, who oversees $4 billion as chief executive officer of Chapel Hill, North Carolina-based fund of funds Morgan Creek Capital Management LLC, said in an Aug. 7 phone interview. “We started to increase exposure in our portfolios to managers who have a little more experience on the short side.”

Short Positions

Greenlight Capital Inc., the hedge fund run by Einhorn, and Redleaf’s Whitebox Advisors LLC in May disclosed short positions in Athenahealth (ATHN:US), a provider of Internet-based services for physician practices. At that time, Whitebox listed 17 other stocks that the firm was betting against, including Salesforce.com and Cepheid (CPHD:US) Inc.

Athenahealth dropped 22 percent in the second quarter, the biggest decline in four years, after rallying an average of 24 percent in the previous three quarters.

Salesforce.com slipped 6.6 percent in July and is down 1.4 percent in 2014. The online customer-management software developer jumped more than 30 percent in each of the last two years. Cepheid, a maker of medical tests that surged 350 percent in the five years through 2013, fell 21 percent last month, extending a 7.1 percent slide in the second quarter.

Unsustainable Gains

“The higher the market goes, the more stocks get pushed up to levels that are not sustainable,” John Thompson, the chief investment officer and founder at Chicago-based hedge fund Vilas Capital Management LLC, said in a phone interview on Aug. 7. His firm is betting on losses in Amazon.com Inc., Netflix Inc. and Tesla Motors Inc. “At some point, multiples on specific sectors are just far too high.”

On July 24, when the S&P 500 reached its 27th closing record this year, the index traded at 18 times annual profits, up 50 percent from its bottom in 2011, the year when it last had a 10 percent correction. Athenahealth, 3D Systems and Amazon all have price-earnings ratios of more than 100.

Consistent stock gains have taken a toll on professional managers. Hedge funds with a bearish market view have seen their assets shrink 25 percent since 2008, data compiled by Hedge Fund Research Inc. show. The HFRI Equity Hedge Short Bias Index sank 19 percent in 2013.

“Last year was a tough year to make money shorting,” Paul Ebner, a fund manager of BlackRock Inc.’s Global Long/Short Equity Fund, said in a phone interview Aug. 7. “We’re now getting into a period where the market sentiment is starting to wane and the enthusiasm has started to come off.”

Risky Bets

Betting against the whole market can be risky at a time when both earnings and the economy are expanding, according to Greg Woodard, a strategist in Fairport, New York, at Manning & Napier Inc. U.S. gross domestic product will grow 3 percent in 2015, accelerating from 1.7 percent this year, according to the median forecast from 84 economists surveyed by Bloomberg.

Profits from S&P 500 companies will increase about 11 percent in each of the next two years, compared with 8.3 percent in 2014, analysts’ estimates compiled by Bloomberg show.

“Any time you get increased macroeconomic worries, that’s going to exacerbate any type of pullbacks and if in general investors tend to be more negative on some stocks, these stocks are probably going to be the first ones to see weakness,” Woodard, whose firm has about $54 billion under management, said by phone on Aug. 7. “Unless you see a sustained downturn, there is probably an uptrend bias in the market.”

Most-Shorted Basket

Goldman Sachs’s measure, which tracks the most-shorted stocks in the Russell 3000 Index with a market value of at least $1 billion, rose 1.1 percent today. It has slipped about 6 percent since June, poised for its second quarterly decline since 2012.

Such losses may help bolster returns for some of the most sophisticated investors who have been penalized by bearish wagers as the S&P 500 has almost tripled since 2009.

The HFRI Equity Hedge index of short-biased strategies fell 0.2 percent in July, outperforming a 1.5 percent slide in the S&P 500. The gauge of hedge funds’ returns is down 3.3 percent in 2014 after losing money in all but one year since 2009.

“For the shorting part, we look for extremely high valuations, hot sexy areas,” Ralph Shive, the South Bend, Indiana-based manager of the $2.7 billion Wasatch Long/Short Fund, said by phone on Aug. 6. “When they’re moving up exponentially, it’s hard to tell when the fever is going to break. This year has been choppier. Fundamentals and valuations are getting a little more discerning and that’s good.”

To contact the reporter on this story: Lu Wang in New York at lwang8@bloomberg.net

To contact the editors responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net Jeremy Herron


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Companies Mentioned

  • JAZZX
    (James Advantage Long-Short Fund)
    • $13.57 USD
    • 0.04
    • 0.29%
  • ATHN
    (athenahealth Inc)
    • $117.97 USD
    • 1.93
    • 1.64%
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