The market is poised for a short interest explosion

One of the perverse ironies of the investment world is that whenever corporate layoffs are widespread and thousands of workers face the pain of unemployment, the stock market tends to jump for joy.

While some analysts who have commented on the phenomenon derisively attribute it to Wall Street’s devil-may-care attitude toward workers, it is more likely the result of corporate cost-cutting that is supposed to have a positive effect on profit margins. But whatever the reason, there’s no denying that when mass layoffs make front-page news, the broad market is bracing for a massive layoff in almost every case.

That’s the reality we’re seeing now as front-page headlines describe a seemingly endless list of job cuts among several major companies. Wednesday edition of Wall Street Journal It offered the latest in layoff series, including Bed Bath & Beyond’s (BBBY) plans to proceed with ‘more layoffs [and] Cut costs,” plus Coinbase (Currency) the decision to cut 20% of its workforce. The day after the two layoffs were announced, COIN stock rose 10% while BBBY stock rose 160% over a two-day period.

Before that, Amazon (AMZN) announce On January 5 it was planning to furlough more than 18,000 workers – roughly 5% of its workforce – in the latest wave of layoffs in the technology sector. According to the WSJ, the job cuts will take place over the coming weeks. Unsurprisingly, Amazon stock bottomed out on the day of the announcement; Since then it has risen to more than 15%.

Other major companies that have recently laid off workers includes: Zillow (ZGwhich has laid off at least 5% of its workforce), Goldman Sachs (p8% of its workforce), Salesforce (CRM10% of the workforce), Vimeo (VMEO11% of the workforce), meta (meta13% of the workforce), Snap (pop, 20% of the workforce) and Twitter – which laid off nearly half of its employees worldwide. In each case, the shares of the companies mentioned here rose significantly after the layoffs were announced.

Aside from the layoffs, the trend of worrying news as it relates to the US economy continues to dominate major news outlets. The latest example of this trend is Reuters Article On January 13th I highlighted US Treasury Secretary Janet Yellen’s warning that the US faces a risk of default by June unless the federal debt limit is increased.

With economic pessimism mounting, the argument could be made that the old Wall Street bromide, “buy when there’s blood in the streets,” applies here. It is no coincidence that the wave of layoffs and bad economic news that began building in late October, and has only increased in recent weeks, served as a major catalyst behind the market rally for the new year.

There’s no denying that the stock market has been (and still is) sitting on a hypothetical powder keg of short interest these past few months. The extent to which traders have sold off and are pessimistic about stocks can be seen in the following chart from SentimenTrader by Jason Goepfert, which shows his Panic/Euphoria pattern in several decades Little. Similar levels of panic among traders (ie accumulation of short interest) were followed by explosive bullish moves in the major indices.

Even after gaining 11% in the S&P 500 since establishing an October low, investor sentiment remains startlingly tepid. As evidenced by the weekly readings in the AAII survey, bullish sentiment has averaged just 23% in the past four weeks – well below the long-term average of 35%. This underscores retail investors’ reluctance to believe the bear is gone, which, from an opposite perspective, supports the potential for additional short covering as investors continue to buy call options as protection again against volatility risk.

Speaking of the options market, Jason Goepfert pointed out Last week, small options traders spent 32% of the total volume buying open put contracts. He points out that this is the third-largest buy-put total in any week since 2000. Furthermore, traders reversed their put options purchases at the highest level in nearly four years, while the ROBO put/call ratio reached 93% (indicating an excess). from a buy-by-buy situation). Moreover, this was the second highest buy/sell ratio in the last 20 years and was only surpassed by the massive sell put buying volume in mid-March 2020.

Moreover, the CBOE buy/hold ratio is giving up one of its highest levels (i.e. heavy buying) in several years. The 13-day moving average of this buy/sell ratio remains near all-time highs as of this writing, which is a sign that traders are still bearish and loaded to the gills with short positions.

Altogether, the above indicators suggest that there is indeed a lot of metaphorical “blood” in today’s headlines, which is likely to be very good news for the stock market’s medium-term outlook (3 to 6 months). I anticipate that the coming months will see a continued recovery in the major US averages as the large bearish bets are gradually covered when it becomes clear that the market has already ruled out layoffs and bad economic news.

Editor’s note: This article covers one or more smaller cap stocks. Please be aware of the risks associated with these stocks.