Short Sellers Gain $13B From Small-Cap Stocks Amid Market Discrepancies

In the overlooked realm of the US equity market — small-cap stocks — short sellers are cashing in. This year, they have realized paper profits nearing $13 billion by betting on price declines in small-, micro-, and nano-cap shares, as reported by S3 Partners LLC. This contrasts sharply with the approximately $140 billion lost from shorting mid-, mega-, and large-cap stocks. These stocks surged for a majority of the year, propelled by a resilient economy, the Federal Reserve’s move towards concluding its interest rate hikes, and the rush in tech stocks due to AI advancements.

The market divide became prominent as giants like Nvidia Corp. (NVDA), Meta Platforms Inc. (META), and Tesla Inc. (TSLA) became primary drivers of stock gains. More than half of the stocks in the Russell 2000 — a measure of smaller companies — fell this year, resulting in a modest 5% rise, a stark difference from the 16% surge in the S&P 500. Steve Sosnick, the chief strategist at Interactive Brokers, commented, “The large tech stocks reaped the benefits of AI hype this year. It’s been a year where the top players dominated.”

Although small-cap stocks participated in the stock rally from June to July, the subsequent downturn hit them the hardest. Short-sellers bagged around $9.7 billion in profits since August, based on S3’s data.

As these shares took a hit, investors pulled out $1.5 billion from relevant funds last week, marking a three-month high, as stated by Bank of America Corp. strategists referencing EPFR Global. In comparison, US large-cap stock funds attracted $5.5 billion.

Rob Haworth of U.S. Bank Wealth Management points out that sector weightings have influenced this underperformance. The group’s limited tech involvement, the year’s standout sector, coupled with significant finance and energy engagements, traditionally the underperformers, played a role. He noted, “Small firms are majorly impacted by economic slowdowns and stringent monetary policies, also bearing the brunt of tighter credit and lending conditions. This has significantly weighed down on small caps.”

Mike Wilson of Morgan Stanley, forecasting a dip in the stock market, advised investors to steer clear of small-cap stocks, vulnerable to inflation.

However, shorting small caps constitutes less than 10% of all short sales, as per S3. Some experts believe there’s potential for small caps to rally. For instance, Bank of America’s Jill Carey Hall opined that market segments pricing recession risks could lead if the economy grows.

Yet, short sellers remain keen. Over the past 30 days, they’ve invested $658 million against small caps, a spike from the previous month. According to S3, top bets over the last month were against Archer Aviation Inc. (ACHR), Air Transport Services Group Inc (ATSG), Alteryx Inc. (AYX), and Sage Therapeutics Inc. (SAGE).

This year’s most rewarding small-cap shorts included regional banks, while wagers against Lumen Technologies Inc. (LUMN), Foot Locker Inc. (FL), and Beam Therapeutics Inc. (BEAM) also yielded profits, as per S3 data.

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Short Sellers Gain $13B From Small-Cap Stocks Amid Market Discrepancies

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