The 3 Most Shorted Sectors in the S&P 500

The 3 Most Shorted Sectors in the S&P 500
By Anthony Jerdine| March 22, 2016

With the stock market sputtering to start 2016, short sellers have emerged from the woodwork. Unlike traditional investors who fret over portfolio losses when the bears take over the market, short sellers welcome turmoil as an opportunity to log profits. This unique breed of financial players attempts to buy low and sell high, just like all stock investors, only they reverse the order of operations. Instead of buying first and selling later, hopefully after the price has increased, they sell first and then buy later, expecting the price to decrease in the interim.

Selling stock before buying it is made possible by borrowing shares from a broker. Those shares must be paid back at some point, which is why short selling is so much riskier than traditional stock investing. When you buy a stock, the most money you can lose is the amount you paid, since the stock can only fall to zero. When you sell borrowed stock on the promise to buy it back later, the price can theoretically rise to infinity, meaning there is no limit on the money you can lose.

Having said that, certain sectors in the Standard & Poor’s 500 index have attracted heavy short-selling activity amid the current stock market turbulence.

Energy
Since 2015, no market sector has engendered more bearish sentiment than energy. The pessimism, of course, springs from the oil price collapse that began during the second half of 2014. From 2011 until 2014, the per-barrel oil price mostly hovered around $100. By early 2016, it had fallen below $30 per barrel for the first time since the 1990s and, as of March 2, 2016, stands at $34.40.

Drilling companies in particular have been decimated by the oil collapse, with their stock prices falling to reflect their financial malaise. Particularly hard hit have been shallow-water drillers, which use machinery that affixes to the ocean floor to extract oil from the ground. These companies tend to rely on short-term contracts. When the price of oil falls, they struggle to find new work to replace expiring contracts.

As of Feb. 25, 2016, 7.7% of outstanding energy company shares are in a short position. This leads the S&P. Analysts do not expect this to change until oil prices recover substantially.

Consumer Discretionary
The consumer discretionary sector is a highly cyclical one that outperforms the market during good times and almost invariably suffers worse-than-average losses during hard times. This sector encompasses most nonessential goods that consumers purchase using discretionary income, meaning the money left over after paying for essentials. New cars, steak dinners, movie tickets, vacations – these fall under the umbrella of consumer discretionary goods and services.

Short-selling activity in the consumer discretionary sector has picked up in 2016. As of Feb. 25, the short interest on outstanding shares in the sector is 6.3%. With certain economic indicators such as a commodities rut, economic weakness overseas and political uncertainty surrounding the presidential election pointing to a potential recession later in 2016, short sellers are naturally gravitating toward the most highly cyclical sectors.

Telecommunications Services
Once regarded as a defensive sector, meaning one that is largely insulated from the market’s ups and downs, telecommunications services has become more cyclical as technology advances. Additional headwinds threatening the sector in 2016 include accounting changes by wireless providers, which boosted revenue in 2015 but should not have the same effect in 2016, as the changes have mostly been made.

The sector’s increasingly cyclical nature, combined with potentially overconfident forecasts spurred by the 2015 accounting changes, have attracted short sellers to telecommunications services. As of Feb. 25, 2016, 5.6% of the sector’s outstanding shares are in a short position.

 

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