Why S&P 500 short interest is a defensive signal

Congress at a stimulus stalemate and rising U.S.-China tensions have not stopped the S&P 500 from marching back up to just 1% from record highs.

Democratic and Republican lawmakers on Friday could not come to an agreement on a relief bill, pushing President Donald Trump to consider executive action. Meanwhile, Trump moved the needle against China again after banning U.S. transactions with TikTok’s parent company ByteDance.

Chris Harvey, head of equity strategy at Wells Fargo Securities, is not concerned either of these headwinds will stall the stock market’s move back to highs. However, he does see other factors that could impede the run.

“What we worry about more is the narrative of negative interest rates coming back, the fact that we think that political risk is underpriced, and back to school is going to have a ton of fits and starts, which could play into the economy and the job picture,” Harvey told CNBC’s “Trading Nation” on Friday.

Harvey is watching one contrarian indicator for signs the stock market recovery rally could be beginning to turn.

“We have seen short interest come down and down dramatically as the market has rallied. That’s a positive sign near term. It tells us that people are much more constructive. There’s a lot of bearishness that’s been rinsed or washed out of the marketplace. However, it also tells us there’s significant scope for that short interest to go up,” said Harvey.  

Short interest on the S&P 500 as a percentage of float was at 3.1% last week, according to Wells Fargo Securities data. That was down from 3.3% in mid-July. Short interest was especially low in utilities, health care and financials.

“Typically, some of the worst sell offs we’ve seen is when short interest rises from very low levels, which is where it is. It’s not a catalyst by itself, but it’s a concern, it’s a concern as we see the market melting up,” said Harvey.

Wells Fargo Securities has a price target on the S&P 500 of 3388. Harvey says the index could hit that level before pulling back as election risks get priced in heading into November.

The S&P 500 closed Friday at 3351.28.

Disclaimer

Source