"Short" investors are back and licking their chops as technology companies continue to issue profit warnings, according to a Thomas Weisel Partners report.
The brokerage said short interest in Standard & Poor's 500 stocks jumped 29 percent for the month ending June 15, representing more than 1 billion shares. That increase offset a 1 billion share decline in May. The increase in short interest was largely attributed to investors who were betting against technology stocks.
Meanwhile, the New York Stock Exchange on Thursday said short interest rose to a record 5.58 billion shares on the Big Board for the month ended June 15.
Shorting a stock means borrowing shares to sell, then "covering" the loan by buying the company's stock on the open market. Short sellers profit from the difference between the price at which they sold and the price of the replacement. Simply put, short sellers are investors who make their money by betting against stocks.
And they are betting big against technology. In fact, the technology sector accounted for 72 percent of the S&P 500's rise in short interest--which are shares of a stock that have been sold but not repurchased. Technology short interest more than reversed its April-to-May decline of 719 million shares, rising 724 million shares, or 155 percent, from May 15 to June 15. Telecommunications providers saw short interest increase 34 percent for the month ending June 15.
Mat Johnson, a strategist at Thomas Weisel, said short sellers swooped in to anticipate profit warnings, a bet that has paid off as companies such as Juniper Networks, Handspring, Nortel Networks, Exodus Communications and a host of others delivered bad news to Wall Street.
"They are clearly anticipating bad earnings," said Johnson, who noted that short sellers have appeared whenever there was a hint of bad news. Short interest in technology was up in January and March and spiked in April and June, according to Thomas Weisel statistics. All of those periods corresponded with profit warnings and disappointing earnings. Shorts tended to cover positions in May, contributing to the Nasdaq's brief run that month.
Johnson said it's likely shorts that will retreat soon, once technology companies complete the profit-warning season. "The second quarter may not be as ugly as we saw in the first," Johnson said.
When the actual earnings come out, short investors are likely to cover their bets on selected tech stocks, he said, adding that telecommunications carriers will remain a favorite of shorts because of funding issues.
Mark Edwards, chief investment officer for the Potomac Funds, which shorts Internet and Nasdaq 100 stocks, said short sellers will likely stick around at least through the end of the year. Until technology executives can say something better than it's "not getting any worse" short sellers will remain, he said.
"The most recent rally was based on just the absence of really bad news," Edwards said. "It appears it was a dead cat bounce."
Other strategists agree. Greg A. Smith of Prudential Financial said technology spending is far worse than had been expected. Smith said a rebound is inconceivable at this point, noting that technology demand started to deteriorate last summer and continued to get worse in the fourth and first quarters and now the second quarter.
Smith said investors will have a better read on an economic recovery at the end of the summer, but by then most projections for a second-half rebound will be moot. "It will be a long time before technology demand recovers to any semblance of its former robust self," Smith said. He also noted that more layoffs could hurt consumer confidence and spark a global recession led by tech companies, a theory also floated by Morgan Stanley economist Stephen Roach.
That's the kind of environment that benefits shorts, which are enjoying a long and profitable run.
Not that Edwards is complaining. Potomac runs traditional mutual funds and ones that short the Dow Jones Internet index and the Nasdaq 100. Assets in Potomac's short funds surged in recent weeks and rotated away from its traditional funds, Edwards said.
Either way, Potomac can benefit.
"In the near-term, I don't see a turnaround for the tech sector anytime soon," Edwards said. "I don't see any enthusiasm out there, and the shorts will dominate in the near-term."