Short bets against U.S. equities are in steady decline, a sign that market bears may be in retreat as the longest bull market in history rages on.
Short interest in the S&P 500, or the percentage of outstanding shares held by short sellers, fell to 2.06% at the end of December 2021, down from 2.44% at the end of 2020 and down from its most recent peak of 3.13% in March 2020 as the pandemic began, according to the latest S&P Global Market Intelligence data. Short selling, in which investors bet on a stock's fall, involves selling borrowed shares in hopes of buying them back later at a lower price.
"After years of betting against a relentless bull market, shorts are running low on conviction and capital," said Matthew Weller, global head of research with FOREX.com and City Index.
Sector declines
Overall, short interest in all public companies that trade on major U.S. stock exchanges fell throughout 2021, with every sector except real estate seeing a decline from the end of 2020 to the end of 2021, according to the latest data.
The consumer discretionary sector finished 2021 as the most shorted of all sectors as short sellers continued to bet that rising inflation and energy prices would continue to eat into spending power.
Still, the sector, largely made up of companies that sell goods and services viewed as nonessential, such as apparel and vehicles, saw its short interest fall from 5.57% to 4.55%.
Healthcare, the second-most shorted sector, saw short interest decline from 5.34% to 3.94% in 2021, while the information technology sector saw short interest fall from 4.04% to 3.2%.
The decline in short interest followed a continued rally in U.S. stocks in 2021. The S&P 500 saw a total return of 28.7% in 2021.
While short activity surged around the retail revolution and the height of "meme stocks," such as GameStop Corp., short sellers are increasingly backing out of their bets as fears of a burst market bubble fade, said Edward Moya, a senior market analyst with OANDA.
"Short selling is in decline for a plethora of reasons," Moya said. "Hope is high that the end of the pandemic is near for the U.S., hedge funds learned their lesson after losing big betting against small-time day traders during the pandemic, and on expectations that the Fed's pivot is really just them becoming less accommodative and not truly tightening conditions."
Still, short selling could pick up in 2022 if 7% inflation extends deep into the second quarter of this year and the Federal Reserve becomes more aggressive in tightening monetary policy, causing a decline in risk appetite and a correction in U.S. equities, Moya said.
The decline in short interest indicates that a stock market correction may be imminent, said Weller with FOREX.com.
"Only once the most ardent bears have thrown in the proverbial towel can we say that everyone has bought and the market runs out of new fuel to drive prices higher," Weller said.