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Earlier in the week I referenced Goldman Sach’s report stating how the unloved stocks are out performing the most owned [and loved] stocks.   Today I will reference a short interest article that has validated some of my arguments as to why the typical stock had greatly underperformed and perhaps as to why the most unloved stocks are now outperforming.

According to Bloomberg, the reported short interest is $1 trillion, an eight year high.  Positon reports from the Commodity Futures Trading Commission (CFTC) indicate managers are more skeptical than any time since at least 2010.

According to Bloomberg in August 2015 bearish investors pushed short interest over 4% for the first time in six years.  By end of February the ratio climbed to 4.4%, the highest since 2008.  Bloomberg writes on March 15 the level was 4.3%, equivalent to a short positon of just under $1 trillion.

Bank America writes in order for the short interest to fall to its six year average, short interest would have to fall by 15%.  The last time it posted a drop of that size after reaching a one year high in September 2010, the S & P 500 gained 16% in the next 6 months.

Several times I have opined—which are defined as statements that are rhetorical and conjectural in nature where there is no evidence to support my comments—there is a large unreported naked short interest.  This is the result of the undue influence of high frequency trading firms that are playing by the same rules of extinct specialist system that dominated the markets until 2012ish.

The SEC states there are six high frequency trading firms that handles about 85% of total volume, firms that were nonexistent 6-7 years ago.  As stated these HFTs have replaced the numerous specialist firms thus inferring a few firms now have the ability to exert undue influence upon the markets and according to the SEC can perhaps create an “unbalanced playing field.”

Naked short interest is not reported however there are many reputable studies analyzing the subject.

I can rhetorically argue a reason why the unloved stocks are outperforming is because of this possible naked interest (and reported short interest).  Because of regulatory and trading changes, a large portion of the market outside of the largest capitalized names is illiquid.  Any buying (or selling) will boost shares.  All must remember fear is more powerful than greed and stock can only fall 100% but can rise exponentially.

Radical thought?  Last month Barclays Bank commented that they believe of  one of the greatest risks to the financial system was a failure to deliver crisis that threatens the viability a HFT firm and a (the) large money center bank(s) that extended credit.  This scenario is similar to that of the 1997 LTCM crisis.

Commenting about yesterday’s market action, equities were up as oil surged over 5% on an expected drawdown in oil inventories.  Equities were also buoyed by the Fed Minutes.  The Committee indicated there was a debate about an April interest rate hike but erred on the side of caution with a loud minority thinking June is now a realistic chance.

The dollar fell to a 17 month low and the 10-year was off 10/32.

What will happen today?

Last night the foreign markets were mixed. London was down 0.05%, Paris down 0.17% and Frankfurt down 0.08%.  China was down 1.60%, Japan up 0.22% and Hang Sang up 0.29%.

The Dow should open moderately lower on a litany of concerns including growth, earnings and monetary fears. The 10-year is up 6/32 to yield 1.74%.

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Ken Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.