Short Sellers Targeting Russell 2000 & Other Small Cap Stocks

Discussion in 'Trading' started by ByLoSellHi, Apr 12, 2007.


    Short Sellers Target Small-Company Shares as U.S. Growth Slows

    By Michael Patterson

    April 12 (Bloomberg) --
    Short sellers are increasingly betting against shares of America's smallest companies, and some of the biggest U.S. investors are equally pessimistic.

    Short positions in companies in the Russell 2000 Index, which have a median market value of $669 million, jumped last month to the highest since at least September 2003, according to Citigroup Inc. Short sellers, who bet on stock declines, are targeting so-called small-cap companies after they outperformed the Standard & Poor's 500 Index for the eighth straight year.

    Bank of America Capital Management, JPMorgan Private Bank and LPL Financial Services, which manage about $1 trillion, are bearish on smaller companies too. They say large-company stocks are cheap relative to earnings and will outperform small caps this year as the U.S. economy slows. Decelerating growth at home favors bigger companies, which get more of their revenue from abroad, the investors say.

    ``The greater the growth scare here in the United States, the more pressure on small caps,'' said Joseph Quinlan, who helps oversee $540 billion as Bank of America's chief market strategist in New York. ``You want to be in large-cap stocks.''

    The percentage of shares sold short in the Russell 2000, a small-cap benchmark, was more than five times greater than in the S&P 500, consisting of companies with a median value of $13.6 billion, according to Citigroup. Short sellers borrow shares from stockholders and sell them, hoping to repurchase them at a lower price later to return to the holder.

    Shorts' Targets

    Their biggest targets among small caps as of mid-March included Accredited Home Lenders Holding Co., a mortgage lender, and Take-Two Interactive Software Inc., a video-game maker, according to monthly data from stock exchanges.

    The Russell 2000 has outperformed the S&P 500 every year since 1998. Since the current bull market began in October 2002, the small-company index has climbed 147 percent, almost double the S&P 500's 85 percent gain. This year, the Russell 2000 has gained 2.6 percent, while the S&P 500 has advanced 1.5 percent.

    Companies in the Russell 2000 sell on average for about 40.1 times earnings for the past year. S&P 500 members are valued at about 17.2 times. The gap between those two price- earnings ratios is the widest since May.

    ``It's not a surprise to me that some smart guys on the other side may be selling or shorting some of these stocks with the anticipation that they'll come back to a more reasonable price level,'' said Mark Keeley, who helps manage the $4.2 billion Keeley Small Cap Value Fund, which has beaten 98 percent of its peers in the past five years. ``That's not a bad bet.''

    Thiel's Bet

    About 9.6 percent of the shares available for trading in the Russell 2000 were sold short in March, according to data compiled by Nicholas Gulden, head of U.S. portfolio trading strategies at Citigroup. That compares with a 1.9 percent short interest in members of the S&P 500.

    Peter Thiel, chief executive officer of Clarium Capital Management in San Francisco, is among the hedge fund managers who are betting the S&P 500 will outpace the Russell 2000.

    ``The way to trade equities at this point in the U.S. is short the Russell and go long the S&P,'' said Thiel, who manages about $2.1 billion. ``The S&P 500 is more multinational, and to the extent that we have a slowdown in the U.S. but not globally, it's probably going to do better than the smaller-cap stocks.''

    The U.S. economy probably grew at an annual pace of 2 percent last quarter, according to a Bloomberg News survey of economists, down from a 2.5 percent rate in the fourth quarter.

    Weathering a Slowdown

    Government and private reports over the past two weeks showed consumer confidence fell for a second straight month, while manufacturing growth slowed more than forecast.

    Jack Caffrey, an equity strategist at JPMorgan Private Bank in New York, says large companies may weather a slowdown better because they tend to sell more goods and services overseas.

    Sales in the U.S. accounted for about 84 percent of the revenue reported by companies in the Russell 2000 last year, according to data compiled by Bloomberg. Members of the S&P 500 relied on the U.S. for 73 percent of sales.

    Economies elsewhere are growing faster than the U.S. Mexico probably expanded at a 3.7 percent pace in the first quarter, according to economists in a Bloomberg survey. China, the world's fastest-growing major economy, probably grew at a 10.2 percent rate, according to an estimate from the country's central bank.

    ``Multinationals -- generally the larger companies -- are better positioned to capture that growth,'' said Caffrey.

    Growing Employment

    Still, the economy may surprise investors with its strength. Hiring in the U.S. last month rose more than forecast, and the unemployment rate unexpectedly fell, indicating slumps in housing and manufacturing may be having limited impact.

    And small caps may get a boost from mergers and acquisitions. About $635.9 billion in takeovers involving U.S. companies have been announced this year, 38 percent more than during the same period last year, according to data compiled by Bloomberg.

    ``The key positive for small-caps right now is all the M&A activity, whether it's from private equity money that needs to be invested or big corporations that have amassed a lot of cash,'' said Dwight Cowden, who manages the $660 million Mellon Small Cap Stock Fund in Pittsburgh. He said three companies in his fund received merger offers in the past four weeks.

    The potential for buyouts may already be reflected in the share prices of many small-cap stocks, said Jeff Kleintop, chief market strategist at LPL Financial in Boston. At the same time, more large companies may get takeover offers as private equity funds collaborate on deals.

    `Overvalued Market'

    Jack Ablin, chief investment officer at Harris Private Bank, bought securities that increase in value if the S&P 100 index of the largest U.S. companies rises more than the Russell 2000. He expects the bet to pay off over the next two years.

    ``This is an overvalued market that can't sustain itself,'' said Ablin, who oversees $50 billion at Harris in Chicago. ``The only piece of the puzzle we're missing here is a little momentum. All the other pieces are in place for small cap to underperform.''
  2. Gonna be a lot of short covering very soon
  3. Knock off the small fry first........then go after the bigger fish.