We are obviously in interesting times whether we are talking about political turmoil, weather extremes or the “pandemic” that doesn’t seem to be going away. If we are talking about national debt in financial terms we are in extreme times. Every day that goes by we have a new all-time record in sovereign debt to GDP both domestically and globally. Recently we have been seeing new highs in stock markets – we just came off all-time lows in long term interest rates. We talked last week about new lows in our Big Banks’ ratio of loans to deposits. We just got back to a new all-time high in the real estate market (U.S.) and a new all-time record with 58% of recent home sales having an accepted offer within two weeks (according to Redit.) Like we mentioned last week the distortions in financial markets – largely due to central bank and government manipulation – are not a good thing and this is going to end badly. However, we don’t see any reason to expect imminent disaster. That being said, the distortions from our fearless leaders are so acute that something completely unforeseen could create serious issues in financial markets.
We have noticed a new all-time record with regard to markets that we find interesting. Short interest is at a new all-time low and appears to be headed to zero:
Short interest is the indication of how many shares of stock are borrow and sold because an investor feels that the stock price will go down. If it does, the investor then buys back the number of shares they sold and give them back to whoever they were borrowed from. Of course, the short-seller is losing money if the stock price is going higher. Short selling has been a part of western-world for centuries now and is much more a part of market-making liquidity than the average investor realizes. This is a fundamental change in our stock markets and is definitely worth noting.
The obvious question is what sort of problems this decline in short interest could cause. One obvious problem has to do with liquidity. In the Covid-19 selloff of last March, many investors sold on the way down anticipating serious economic issues from the coming lockdowns. Many of the buyers of what nervous sellers were liquidating were short sellers covering their positions. This reduced volatility in an ALL TIME record high volatility time. No one knows how crazy March would have been last year if there weren’t short covering buyers to sell stock to. Even if you are a buy and hold strategy investor – no one wants to see double digit declines.
Going forward this is one more extreme that shows just how much our financial markets are changing. Market participants have largely given up on hedging risk – as that can cost portfolio performance if the market is going straight up. Many market timing strategies have sold when the sell signal hit, but have yet to get back into the market as there hasn’t been enough of a market pullback to trigger buy signals. The next time the market gives a pretty obvious buy signal – market timers should be careful.
Regards and good investing,