The latest short interest data was released to the Street earlier today showing that short sellers are starting to ramp-up their bets. For the most recent two week reporting period, cumulative short interest on S&P 500 companies rose by about 1.7%.
The increase in broad market short interest — the first we’ve seen since the market rally started in November — indicates that the shorts are starting to bet more heavily on a decline in stocks.
The data always gets more interesting when dissected at the sector level, though. The table below displays changes to the cumulative short interest for the exchange-traded fund of each sector, calculated by taking the sum of the component companies of each ETF. (This method yields better results that simply look at the short interest for the ETFs themselves.)
During the most recent period (about two weeks), short interest on stocks in the Homebuilders SPDR (NYSE:XHB) rose the most, increasing nearly 6%. As with the broader S&P 500, short interest on homebuilders has been on the decline … but for an even longer period. Short interest for the sector peaked in June of 2012 — a signal that provided one hell of a bullish trade. XHB shares climbed more than 50% from June to their recent top as the short squeeze that ensued last months, not days.
The most basic analysis of the chart above yields a lackluster outlook for the homebuilder sector. The “catch” is the shift in the long-term short interest trend. Most investors have heard the term “the trend is your friend,” but only the experienced know the rest of the phrase is “except at the ends.” Trends tend to reverse and become not-so-friendly — something that applies to indicators like short interest activity.
Typically, we identify abnormally high short interest on a stock that is performing well as a bullish signal since a short squeeze is probably imminent. In this case, low short interest serves as a warning sign that the Wall of Worry — which we like as a contrarian indicator — has decayed for the short-term.
The simplest view of the cumulative XHB short interest trend suggests that homebuilders could be in for a pullback, or at least a rest, over the next few months. Note that the last trough in this trend, March 2011, preceded a slowdown, and near-after an intermediate-term top, in the homebuilding sector.
For now, the research suggests that investors looking to outpace the market’s gains may want to look somewhere besides homebuilders … and that those still holding a hefty allocation might want to trim some profits from their portfolios.
As of this writing, Johnson Research Group did not hold a position in any of the aforementioned securities.