Short-Sellers Set-Up Shop As Sentiment Starts To Shift

"It's dangerous to be short still, but we might be building toward a moment where the market becomes quite vulnerable," warns Bill Fleckenstein who is finishing up the documentation on a new short fund he is about to start marketing. With the slowing growth of the Fed balance sheet, over 70% of the S&P's gains since 2011 from hope-driven multiple-expansion alone, bond and equity market sentiment at extremes, and (as Goldman warned) valuations anything cheap; it is hardly a surprise that, as Reuters reports, after years of hiding under their desks, short sellers are re-emerging – slowly. Whether outright short or long/short funds, the market-share of this corner of the business bottomed at approximately 25% in 2013, but in the last weeks, several S&P 500 companies have seen large increases in shares borrowed for short bets; and the "tide might be turning."

Sentiment extremes in stocks…

and bonds…

Fed balance sheet growth slowing and dislocated from the equity exuberance…

Multiple-expansion the only hope left…

And Goldman dashing those hopes…

S&P 500 valuation is lofty by almost any measure, both for the aggregate market (15.9x) as well as the median stock (16.8x). We believe S&P 500 trades close to fair value and the forward path will depend on profit growth rather than P/E expansion. However, many clients argue that the P/E multiple will continue to rise in 2014 with 17x or 18x often cited, with some investors arguing for 20x. We explore valuation using various approaches. We conclude that further P/E expansion will be difficult to achieve. Of course, it is possible. It is just not probable based on history.

The current valuation of the S&P 500 is lofty by almost any measure, both for the aggregate market as well as the median stock: (1) The P/E ratio; (2) the current P/E expansion cycle; (3) EV/Sales; (4) EV/EBITDA; (5) Free Cash Flow yield; (6) Price/Book as well as the ROE and P/B relationship; and compared with the levels of (6) inflation; (7)
nominal 10-year Treasury yields; and (8) real interest rates. Furthermore, the cyclically-adjusted P/E ratio suggests the S&P 500 is currently 30% overvalued in terms of (9) Operating EPS and (10) about 45% overvalued using As Reported earnings

Is it any surprise that the Short-sellers are setting-up shop once again as greed dominates fear… (via Reuters)

After years of hiding under their desks, short sellers are re-emerging – slowly.

…

Buying the most heavily shorted stocks was a much better bet than the S&P 500

Jim Chanos, president and founder of Kynikos Associates and one of the most prominent short sellers, said the market is primed for people like him and as a result he has gone out to raise capital.

"Now I think is not a bad time to be raising capital for what we do. When we got a rough going in the mid-90s, that was exactly the time to raise capital," Chanos said, adding it was better to do this when critics viewed him as "like the village idiot and not an evil genius."

Already, there are signs 2014 may be different.

…

"We're about done with the document and I'll be marketing it officially very shortly, like within a week," he said.

That's not to say he is brimming with confidence – not yet.

"It's dangerous to be short still, but we might be building toward a moment – whether it's two weeks from now or 10 months from now I don't know, where the market becomes quite vulnerable," said Fleckenstein.

…

"There's growing interest on (shorting) a number of stocks, concentrated in areas that did well last year," said Brian Jacobsen, chief portfolio strategist at Wells Fargo Funds Management in Menomonee Falls, Wisconsin.

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"Biotech is in full bubble mode, meaning companies that have no prospects of a drug continue to grind higher," said John Hempton, chief investment officer and founder of Bronte Capital, a Sydney, Australia-based asset management firm that often takes short positions.

Short sellers say they believe bulls may be getting too confident. The S&P 500's forward price-to-earnings ratio is at its highest since mid-2007.

…

"Short selling over the last two years has been a hedge against profits," said Douglas Kass of hedge fund Seabreeze Partners Management Inc. But he said recent disappointments from companies as varied as Ford, Intel, and Elizabeth Arden are signs that the "tide might be turning."