Short sellers are on the run, with the practice of betting against the stock market at its lowest level since before the financial crisis, according to a study published in the Financial Times.

short selling

Decline in short selling due to hedge funds

The decline in short selling, primarily due to hedge funds, comes as many well-known hedge funds have expressed concern regarding economic stimulus potentially building an economic foundation on sand. Recent warnings from Baupost’s Seth Klarman (although the hedge fund does not short), CQS’s Michael Hintze and David Einhorn of Greenlight Capital regarding distortions being caused by artificially low interest rates causing bubbles in some asset classes aside, the short parade seems to have subsided along with volatility. Einhorn, for instance, has termed many of the valuations in the high-flying tech stocks an official “bubble.”

But it doesn’t matter.

Short selling in the S&P 500 and FTSE all time low

Short interest among stocks in the S&P 500 (INDEXSP:.INX) index, for instance, is near two percent, the lowest level since Markit, the research firm conducting the study, began collecting the data in 2006. Short interest in the FTSE All-Share index is even lower, standing at under one percent.

The record low short interest contrasts with the year leading up to the US financial crisis.  As the realization spread around Wall Street that the bank derivatives products upon which much of their balance sheets had become reliant were in fact faulty, the short interest hit 5.5 percent.

Short selling: Stock market uplifted by cheap money

Today’s stock market has been uplifted by cheap money from central banks who are eager buyers for mortgage-backed assets the banks no longer wanted as well as US debt instruments that would likely be reflecting more risk in the market if they were allowed to float freely.

But such talk of market manipulation – an illegal offense depending on the source of the manipulation – is not in style as the US Federal Reserve has indicated it may operate like a hedge fund and hold its short debt trade until maturity. Who needs marked-to-the-market accountability when you’re the Fed?

Is the low volatility market a sign of more volatility to come?

“Historically, periods of low volatility usually lead to further periods of volatility, they are not precursors to a crisis,” Antonin Jullier, global head of equity trading strategy at Citi, was quoted as saying in the article. “Hedge funds have underperformed in the first half and this means their appetite for risk has fallen over the year,” he said.