September 21, 2022

Short Story

Are traders shorting your stock?

There’s a good article in IR Magazine by independent board director Rosalind Kainyah on what she expects from the company’s IR team.  One data point: Comparative shorting for the company and peers.

The trouble is most Boards and c-suites think only about Short Interest. It’s a 1974 measure created by the Federal Reserve to track the use of margin accounts.  It’s not an SEC metric, let alone one suited to a market that’s 100% electronic, 97% algorithmic.

After the USA left the gold standard in 1971, financial-asset volatility exploded. The Fed feared it wasn’t accurately tracking the money supply. So it created Regulation T requiring a 50% margin in eligible accounts.

Short Interest reports twice per month were born. The measure hasn’t changed in 48 years.

Short Volume is a 2010 measure reflecting the SEC’s passage of a modified uptick rule called Regulation SHO Rule 201.  It defines certain restrictions on shorting stocks and it’s part of Regulation National Market System governing the stock market now.

What’s more, Short Interest is a consequence of Short Volume (there must first be shorted shares before there can be Short Interest). Why meter the consequence if you can measure the cause?

So that’s what we assess – in everything – at ModernIR, applying proprietary smoothing techniques reflecting market rules.  We’ve been tracking that data since Finra implemented regulations for brokers about reporting it.

We call Short Volume “Supply,” because it’s the stock market’s supply chain. That is, most large orders to buy or sell are in part or in whole facilitated by borrowed stock.

(EDITORIAL NOTE: The SEC wants a “continuous auction market” and so exempts market-makers from having to locate shares to short. If you want to know more, Google “SEC market-maker short exemption” and click “Key Points About Regulation SHO –”.)

Source: Market Structure EDGE Broad Sentiment data, Sep 20, 2022

When Demand is rising and Supply is falling, stocks rise. That condition manifested briefly when the market hit 2022 highs to end March, and again from June option-expirations to August options-expirations (SEE FIRST IMAGE).

The reverse punctuated the 2022 low for stocks into June options-expirations. That was a record high for Supply.

Until now. 

Currently, 52% of S&P 500 volume is short, borrowed. That means a minority, 48%, is stocks the buyers and sellers own.

Take a good look at the image.  Demand is decent, over 5.0 (baseline for rising prices). But the supply chain is overloaded.

Your Board and c-suite would no doubt like to know the Supply/Demand balance in your stock, your peers, your sector, industry. 

Speaking of adding value, the client-services team at ModernIR hosted a panel on using market-structure data in IR. Thank you, Clay Bilby, IR head at Palo Alto Networks (PANW), and Matt Garvie, VP IR at US Xpress (USX), for sharing your approaches.

While that panel was unfolding, I was in New York to present at the IR Workshop for the American Gas Association, and I focused on using data to engage the c-suite and Board. You can see a condensed version of my slides here.

Data is king. 

Back to the Short story, VIX options expire today with the whole market shorted, and Jay Powell hiking rates 75 basis points or more.

The market might rise, even so.

I’m not saying it’ll happen! But there will be effort by the parties who are NOT short to move the market in a way that mitigates risk.  It won’t surprise me.

The central tendency though is that a market with topping Demand well shy of historical tops that’s simultaneously the shortest on record will fall. 

We could take a drubbing.

It will be essential to watch the supply chain, Short Volume.

Unless and until those levels recede in a sustained and meaningful way, the bias of the market will be down.

And it doesn’t matter what the news is. Market Structure tells you what everyone thinks – longs, shorts, global macro, asset allocators, stock pickers, risk managers, all of it.

Everything occurring in the stock market rolls up into Demand, and Supply.

That same data in your stock will tell you ahead of results what’s likely to happen, no matter if you beat or miss.  It will tell you if investors buy your stock on non-deal roadshows. It’ll tell you who to call this week among your holders.

If the stock market rallies today, tomorrow, Friday, know it’s quicksand unless Short Volume comes down. Without a supply-chain change, the market will be lower a week from now than it is today.

Maybe a lot lower. That’s the short story.

Photo courtesy Tim Quast, Sep 19, 2022.

PS – And this second image is the view up 8th Avenue from W 43rd in New York City Monday Sep 19 from the 38th floor of the Westin. That tallest building is the latest Billionaires Row addition on West 57th. The penthouse is yours for $250 million.

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