The U.S. stock market should be given the benefit of the doubt over the next 12 months, according to an analysis of short sellers’ recent transactions.
This upbeat message may incline you to view short sellers more positively. They’ve never had a particularly good reputation, since many believe — I think wrongly — that there’s something untoward about betting that a stock’s price will go down.
For this column, I’m not interested in short-sellers’ integrity and virtue (or lack thereof). My focus instead is on whether their behavior can be used to time the market.
The answer is a resounding yes, according to research conducted by Matthew Ringgenberg, a finance professor at the University of Utah and one of academia’s leading experts on short selling. In research published in the Journal of Financial Economics in 2016, he reported that “short interest is arguably the strongest known predictor of aggregate stock returns.”
In an interview earlier this week, Ringgenberg added that short interest for the most part has continued to do an admirable job in the six years since his research was published. A year ago I reported that Ringgenberg’s data was bullish for the subsequent 12 months: “Short-selling may be helping to keep the bull market alive,” I wrote.
Fortunately for the market now, short-sellers’ message is slightly more bullish than it was a year ago. This is evident in the chart above, which plots an equally weighted average of individual stocks’ short-interest ratios. Notice that this average today is slightly lower (and so more bullish) than it was in early 2021.
Read: Retail investors are betting that Bed Bath & Beyond is the new GameStop, but is that even possible?
What’s more noteworthy is the contrast with how short sellers behaved leading up to and during 2008’s Great Financial Crisis (GFC). As you can see from the chart, they became increasingly bearish over a couple of years prior to the GFC, and became even more bearish in the first months of 2008, just as the bear market was beginning. It’s a relief that the short sellers are not reacting in the same way now. The “short seller data do not support an expectation of a bear market,” Ringgenberg said.
At the same time, it should be noted that short sellers haven’t reacted to the market’s recent selloff by becoming significantly more bullish. So the market outlook hasn’t gotten any better either.
Ringgenberg summed up the current message of the short sellers: “The market over the next 12 months is likely to behave much as it has in recent years.”
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at firstname.lastname@example.org
More: 12 dividend stocks paying at least 3.5% that are well-suited for high inflation
Also read: The end (of the stock market correction) may be near