The Nub

One by one, short sellers are being forced to capitulate as market expectations grow for a slower pace of central bank tightening. Whether in stocks or bonds, bearish bets are being dealt a blow as US data begin to reflect the fallout from the Federal Reserve’s aggressive rate hikes. A dovish pivot by the Reserve Bank of Australia on Tuesday is also fanning speculation that policy makers may be about to soften their hawkish stance. Short sellers are being forced to fold during the best two-day equity rally in the US since April 2020, after raising bearish wagers in one of the longest stretches in years. While the latest revival in risk appetite has wrong footed the naysayers, some analysts, including Goldman Sachs Group Inc. and Bank of America Corp., say that the rout has yet to run its course.

Why Does it Matter

“Investors are looking for any sign they can find that central banks will ease up on their tightening cycles,” said Lauren Goodwin, economist and portfolio strategist at New York Life Investments. This comes after the S&P 500 climbed more than 2.5% for a second straight session. At the center of the rally are most-shorted stocks, as tracked by Goldman Sachs Group Inc., which jumped almost 6% as a group on Tuesday, handing losses for those who had placed bet against them. The surge is dealing acute pain for professional speculators, who raised shorts last month as the S&P 500 plunged to fresh bear-market lows. For 11 straight sessions through Thursday, hedge funds tracked by Morgan Stanley boosted short positions against exchange-traded funds, sending their overall equity exposure to a 13-year low.

What Next

The comeback in stocks, after the S&P 500 suffered its worst September in two decades, is also a headache for rules-based funds that had boosted bearish equity bets as volatility spiked and the market lost momentum. Trend followers like commodity trading advisors, for instance, last week saw their equity positioning approaching the trough observed at the height of the 2008-2009 global financial crisis, JPMorgan Chase & Co.’s data show. “Shorts remain extreme from the CTAs to the hedge funds,” said Andrew Brenner, the head of international fixed-income at NatAlliance Securities. While short sales have helped skeptics such as hedge funds fare better during 2022’s bear market, they at times became a source of stress when a sudden share rally forced a squeeze.