Too Many Short Sellers?

1.) CONTRARIAN – As an investor, it usually tends to pay to be contrarian… thinking against the prevailing market narrative. Financial TV and FinX (X’s social media platform) are mostly all yelling the same thing right now. CNBC says a -10% correction is coming because “that’s what always happens” before midterms. Goldman Sachs says hedge funds are the most deleveraged (think de-risked) they’ve been all year. Sounds bearish and scary, yes? But then ask yourself, if those statements are true, and investors have acted on that “expectation of a drop,” who is left to sell? You need sellers for a -10% drawdown. We don’t have to take a stand on being bullish or bearish over the next month. At the end of the day, no one knows exactly how things will play out. But one thing I do know is that when everybody is expecting a -10% correction, it tends not to happen. Could we get some correction? Sure. Markets are dynamic. But right now, given all the information available, I’d say there’s a 65% chance we see markets stay flat to up over the next 45 days. And about a 35% chance we see a correction in the -1% to -7% range. Remember, the Nasdaq 100 has already experienced a -3.5% correction in August before finding some support. Of that 35% chance of a pullback, there's maybe only a 5% chance that we actually experience that -10% drop that everyone seems to “know” is coming. Could that be wrong? Sure. But we'd likely need some "unknown unknown" for that to materialize. Bear in mind, markets tend to be less reactive to things that have happened before. “Known knowns” are rarely what takes markets down hard.

2.) SHORTS – Buyers don’t have to sell, but short sellers (at some point) HAVE to buy! That’s an important thing to keep in mind when we see short seller interest on the median S&P 500 stock moving to decade-highs! That doesn’t spell doom to me. It points out a whole additional class of forced buyers. The media will use data like this to make you think because short sellers are shorting even more (a big bet markets drop), markets must be ready to fall. Again, it tends to not work that way. Short sellers are notoriously wrong on directionality over a more intermediate-term timeframe. Short sellers tend to provide a floor for markets and in many cases force markets higher as they are forced to buy to cover their positions. I tend to get more concerned when the short sellers have left the building… like in 2022. Today looks nothing like that.

3.) VALUATIONS – There is also a lot of noise about “this market being the most expensive ever.” Really? That’s not what I see. Earnings accelerations have actually brought multiples down. In fact, if forward earnings estimates continue rising at their current pace, the S&P 500 may only need a 19x forward Price to Earnings (P/E) multiple to reach 8000 by year-end. I know that sounds nuts given all the "correction" noise right now, but a 19x multiple is not the most “expensive” ever.