Short-Covering Frenzy More Concentrated Than Stock Moves Suggest

(Bloomberg) -- The bout of short-covering that roiled global markets last week looks highly concentrated in just a handful of small-cap stocks rather than a more extensive phenomenon.

The absence of a more widespread trend is even evident within the 25 members of the Russell 2000 Index that are most bet against. The average level of short interest in these shares fell just three percentage points to 38% on Thursday, from 41% at the beginning of the year, according to data compiled by Bloomberg. The level of bearish bets -- which is calculated as a percentage of free float -- is still higher than the 34% it was a year ago.

Violent swings in smaller stocks like GameStop Corp. and Bed Bath & Beyond Inc. -- as a surge in bullish retail investor wagers attempted to squeeze institutional short positions -- hurt broader market sentiment last week. The S&P 500 Index saw its biggest weekly decline in three months as investors speculated hedge funds were being forced into reducing their market exposure.

The volatility did lead some investors to pull back from riskier positions. Goldman Sachs Group Inc.'s Prime Services team saw the largest reduction in exposure since 2009, with activity concentrated in single stocks, according to a research note Friday.

“Trading activity on the GS Prime book suggests hedge funds significantly reduced their exposure to U.S. single stock shorts this week,” wrote the Goldman strategists. “The pace of de-risking was even more violent in the less liquid, medium and hard-to-borrow names.”

The 25 most-bet against names in the U.S. small-cap gauge are led by GameStop, which saw its short-interest as a percentage of free float plunge to 59% Thursday from 115% two weeks ago. But other stocks on the list saw much more modest short-covering, such as Ligand Pharmaceuticals Inc., where it fell to 63% from 64% over the same period.

Despite the surge in volatility, some strategists doubt the attacks on short positions can have a lasting impact on the broader market. The most-heavily shorted companies targeted by day traders this year had bearish wagers amounting to less than 0.001% of the $43 trillion stock market, Barclays Plc strategists led by Maneesh Deshpande calculated in a recent note.

Strategists at JPMorgan Chase & Co. are of a similar opinion.

“While Russell 2000 stocks, where many companies with high short interest are included, saw a sharp decline in their short interest in recent days, at an aggregate level of all U.S. stocks there was little change in short interest,” wrote JPMorgan's Nikolaos Panigirtzoglou in a note Friday. “In other words, the short squeeze reflects a narrow universe of smaller U.S. stocks rather than a broader market shift.”

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