Investors are increasing bearish trades around the world by the most in at least five years, convinced the lowest valuations since 2009 will prove no barrier to losses after $11 trillion was erased from equities.
Borrowed shares, an indication of short selling, climbed to 11.6 percent of stock last month from 9.5 percent in July, the biggest increase since at least 2006, according to information compiled for Bloomberg by Data Explorers, a London-based research firm. Trades that profit when Chinese equities decline have reached a four-year high and bearish bets in the U.S. are the most since 2009, exchange data show.
Slowing economies are spurring short sellers after indexes in 37 out of 45 major countries tumbled 20 percent, the common definition of a bear market. Bulls say declines have gone too far, with the MSCI All-Country World Index's valuation at about half the 16-year average, just above the level three years ago, following the collapse of Lehman Brothers Holdings Inc. Losses since May exceed the combined gross domestic product of Brazil, Russia, India and China, data compiled by Bloomberg show.
“The Lehman collapse is way too clear in people's minds,” said Henrik Drusebjerg, who helps oversee $230 billion as senior strategist at Nordea Bank AB in Copenhagen. “They don't want to get burned as much again. They know either they get some protection or get out altogether.”
Europe Crisis
The MSCI All-Country World advanced 2.6 percent at 4:15 p.m. New York time. It has risen 7.7 percent during the past four days, the biggest rally since April 2009. Stocks rose last week after efforts by Europe's policy makers to contain the region's debt crisis. The gauge of 45 emerging and developed countries sank 18 percent in the third quarter, the biggest drop since the bankruptcy of New York-based Lehman froze credit markets and ultimately pushed the Standard & Poor's 500 Index to a 12-year low.
U.S. Federal Reserve Chairman Ben S. Bernanke said last week that the central bank can take steps to sustain a recovery that's “close to faltering.” Employers added 103,000 workers to payrolls in September and the unemployment rate held at 9.1 percent, the Washington-based Labor Department said Oct. 7.
The bond market indicator that has predicted every U.S. recession since 1970 now shows that the economy has a 60 percent chance of contracting within 12 months. The so-called Treasury yield curve, adjusted for distortions caused by the Fed's record low zero to 0.25 percent target interest rate for overnight loans between banks, shows that two-year notes yield 20 basis points, or 0.20 percentage point, less than five-year notes, according to Bank of America Corp. research.
Biggest Increases
Alcoa Inc. (AA), the largest U.S. aluminum producer, is the most shorted stock in the Dow Jones Industrial Average with bearish bets making up 4.4 percent of the New York-based company's shares available for trading, according to Data Explorers. Pfizer Inc. (PFE) and General Electric Co. (GE) had the biggest increases in short interest last month among companies listed on the New York Stock Exchange.
Short selling is increasing even as equities approach the cheapest valuations on record. The MSCI All-Country World trades at 11.8 times reported profit, compared with 11.9 in the five months after Lehman's collapse. The measure's average price-earnings ratio since 1995 is 21, data tracked by Bloomberg show.
European stocks fell the most last quarter among the world's biggest equity markets, with the DAX Index of German shares and France's CAC-40 Index each losing 25 percent. Finance leaders have clashed over how to prevent Greece from defaulting on its debt, spurring concern that losses may engulf banks in France and Italy.
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“The downside risk if the euro-zone cracks is so huge that the market could go anywhere,” said Francis Eliot, a strategist at Mansard Capital LLP, whose Mansard Macro Fund returned 3.9 percent last month as the MSCI All-Country World Index tumbled 9.7 percent. “The short trade is a bit crowded, but the risk is downward.”
Stock Valuations
Equity valuations are already pricing in a recession and stocks are unlikely to fall much below the lowest levels of last week, according to Binky Chadha, the New York-based chief U.S. equity strategist at Deutsche Bank AG.
“Valuations and short interest are approaching Lehman levels,” Chadha said in a telephone interview on Oct. 6. “It's not very easy to continue to take larger and larger short positions.”
Companies in the benchmark gauge for American equities trade at 10.4 times 2012 forecast earnings, compared with the average in economic contractions since 1957 of 13.7, according to data compiled by Bloomberg. At the same time, analysts have cut projections for profits next year to $111.46 a share, the data show.
Short sales in New York-based Pfizer, the world's biggest drugmaker, rose 22 percent to 111 million shares in the first two weeks of September, exchange data show. That's 2.51 times the average trading volume from the past 30 days. The S&P 500's short interest ratio is 3.19, data compiled by Bloomberg show.
GE, Strategists
Bets on losses in GE, which makes wind turbines and jet engines, climbed 13 percent to 141 million shares between Aug. 31 and Sept. 15, the most since August 2009. Short interest on the Fairfield, Connecticut-based company has more than doubled in 2011 as the stock slumped 15 percent.
Wall Street strategists say the S&P 500, after falling within 1 percent of a bear market last week, will post the biggest fourth-quarter rally in 13 years. The measure will climb 13 percent to end 2011 at 1,300, according to the average estimate of 12 strategists surveyed by Bloomberg.
About 4.1 percent of NYSE shares have been borrowed and sold, up from 3.5 percent at the end of July, data from the bourse shows. U.S. short sales are rising at the second-fastest pace on record after the 2008 financial crisis, according to exchange data dating back to 1995.
March 2009
Bearish bets last increased faster in March 2009, the same month the S&P 500 began a bull market that doubled its value. The surge in equity prices came seven months after NYSE short interest climbed to an all-time high in July 2008. The U.S. equity benchmark rose 2.1 percent to 1,155.46 last week.
“We have more shorts on today than we had six months ago,” said Chris Baggini, a fund manager at Berwyn, Pennsylvania-based Turner Investment Partners Inc., which oversees about $18 billion. “We're finding more short ideas in the U.S. market that we think we can make money on in an environment that's slower than it was six months ago.”
Baggini, who spoke in an Oct. 6 telephone interview, helps oversee the Turner Spectrum Fund that climbed 5.9 percent in the 12-months ended Oct. 6. The S&P 500 fell 0.2 percent in that period.
Bets that Hong Kong stocks will fall have risen to the highest level since January 2008 amid falling home sales in China and concern that the world's second-largest economy is slowing. Wagers on declines reached HK$12.8 billion ($1.6 billion) on Sept. 30, Hong Kong exchange data show. That's 14 percent of the total value traded on the city's stock market, the most since 1999.
Foreign Investors
The MSCI China (MXCN) Index of 148 stocks available to foreign investors has fallen 26 percent since Aug. 1. China's home prices fell 0.03 percent from a month earlier in September, the first decline in a year, said Soufun Holdings Ltd., the country's biggest real estate website owner. The central bank has raised interest rates five times in the past 12 months.
Alex Au, who helps oversee $300 million as managing director of Richland Capital Management Ltd. in Hong Kong, said he's “aggressively” shorting cement stocks on speculation spending on roads and factories will weaken. Anhui-based Anhui Conch Cement Co., China's largest producer, has lost 47 percent since its July 14 peak. The Richland Asia Absolute Return Fund rose 3 percent this year through Sept. 30, versus the MSCI Asia Pacific Index's 18 percent drop.
‘Yet to Come'
“The worst is yet to come,” Au said in an Oct. 4 phone interview. “If you look at the fundamentals, you'll see that a lot of stocks are very cheap and you'll be tempted to bottom pick, but this is very dangerous.”
Average short interest in Europe as a percentage of shares outstanding has climbed to 2.8 percent, the highest since June, from 2.6 percent at the beginning of September, according to Data Explorers. Regulators in Italy, Spain, France and Belgium banned new short sales on 66 financial firms on Aug. 11, when the Euro Stoxx Banks Index had plunged 33 percent this year.
Filippo Garbarino, who oversees $50 million as manager at Frontwave Capital Ltd. in Chiasso, Switzerland, said he has bet against shares of financial and publishing companies.
“The market is so undervalued right now it's kind of hard to take a short position,” Garbarino said. “But at the same time given the economy, it is hard to be long.”
--Bloomberg News--
