The Most Painful Part Of The Short Squeeze May Be Yet To Come, JPM Warns

Two weeks ago, we reported that NYSE Short Interest has risen 4.5%, back over 18 billion shares near the historical record highs of July 2008 (and up 7 of the last 9 months).


We said that this dynamic means one of two things:

  • Either a central bank intervenes, or a massive forced buy-in event occurs, and unleashes the mother of all short squeezes, sending the S&P500 to new all time highs, or
  • Just as the record short interest in July 2008 correctly predicted the biggest financial crisis in history and all those shorts covered at a huge profit, so another historic market collapse is just around the corner.

So far not a single central bank or major policy-making institution has intervened with a major (or for that matter, any) stimulus, but the expectation that one will - be it the G-20 last weekend, China this weekend, the ECB next week or the BOJ the week after - has led to precisely one of the two postulated outcomes: as we reported yesterday, the "mother of all short squeezes" was indeed unleashed, and last week the "most shorted" stocks were up a near record 8.7%, the highest since the furious November 2008 bear market rally.


So does this mean the short squeeze - whether ordinary course of business or engineered by banks to push the price of both the S&P and oil higher so that energy companies can sell equity and repay secured bank loans (as we speculated last week) - is over? According to JPM, not just yet, even though by now the weakest hands have clearly tapped out. In fact, since there has been virtually no rotation into ETFs, the most brutal part of the squeeze may be just ahead. Here's why:

The covering of short equity positions continued over the past week. The short interest in US equity futures declined over the past week as seen in Figure 1.



But its level remains very negative suggesting there is room for further short covering. The short interest on SPY, the biggest equity ETF, at 4.75% stands below its recent peak of 5.43% but it remains elevated vs. its level of 3.54% at the start of the year. Equity ETFs have not yet seen any significant inflows, suggesting that ETF investors have done little in actively reversing the almost $30bn of equity ETFs sold over the previous two months. CTAs, which have been partly responsible for this year’s selloff, are still short equities and they have only covered a third of the short position they opened in January. In contrast, Discretionary Macro hedge funds, Equity L/S, risk parity funds and balanced mutual funds, appear to be modestly long equities, so they are currently benefitting from the equity rally.


Is it possible that the short squeeze can take the S&P another 100 points higher, reaching Goldman's 2016 year-end target even as GAAP EPS have crashed to just over 90, and which would mean that the market when valued on a GAAP basis would be at 22x earnings and the most expensive it has ever been? Of course it is, even if that will make the S&P500 the most overbought, and overvalued in history, and just ripe for the next wave of short selling.

So for all those eager to short the S&P but unsure when to do it, keep an eye on the SPY short interest and CTA net exposure. Breakout failures would mean this week's roundhouse punch to the face of market shorts may be as bad as it gets.  On the other hand, if the covering momentum is only just starting, and now it is the ETFers and CTA's turn to pick up the baton, the next move higher in this bear market squeeze could easily take the S&P500 to new all time highs.