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Why Tesla bulls are in the driver’s seat as the stock nears inclusion in the S&P 500

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The most heavily shorted stocks underperform the broad market, on average. But try telling that to Tesla
TSLA,
-1.03%

 bulls, who at least so far have enjoyed the last laugh at short-sellers’ expense. In January 2020 Tesla was the most heavily shorted U.S. stock, with 18.2% of its float (total tradable shares) sold short. Yet the stock’s gain this year so far is nearing 700%.

Ihor Dusaniwsky, managing director of predictive analytics at S3 Partners, who focuses on the share-lending market that supplies shares to short sellers, was quoted in Institutional Investor in mid-August as saying that the bet the short sellers are making against Tesla is “by far the longest unprofitable short I’ve ever seen.” Tesla’s stock has since gained more than $200 a share.

Is this time different? I know that these are the four most dangerous words in investing. But Tesla’s short squeeze seems so exceptional to make it at least worth asking the question.

Going long against the shorts

If you’re a contrarian, you may wonder what all the fuss is about. Contrarian analysis argues that high levels of short interest are bullish. So, far from being an exception that demands explanation, what’s happened to Tesla this year is precisely what contrarians would expect.

The problem with this contrarian argument is that it’s wrong, according to Adam Reed, a finance professor at the University of North Carolina. The strong consensus finding of those numerous academic studies over the decades is that heavily shorted stocks proceed, on average, to underperform the market.

To be sure, the contrarian story about short interest makes a certain amount of intuitive sense: Shorts eventually have to be covered, so a high level of short interest represents a lot of potential buying power. But any positive impact of short covering is temporary.

One of the experts I contacted to ask whether “this time is different” is Jay Ritter, a professor of finance at the University of Florida who is the co-author of one of the most-cited academic studies on the investment implications of short interest. He disclosed to me that he himself is short Tesla.

No, he doesn’t think this time is different. To be sure, he acknowledged, there’s always the worry that a stock market pattern will stop working once it becomes widely known. But, he said, it’s unlikely that the market-lagging performance of highly shorted stocks will be discounted away anytime soon. That’s because there are a number of structural and behavioral barriers that make it harder for an investor to sell a stock short than to own a stock on the long side.

UNC’s Reed offered several reasons why this asymmetry exists:

  • It can be difficult and costly to borrow shares in order to short them. There is no analogous cost to someone buying stocks on the long side.

  • The potential loss of a short sale is infinite, so the practice is especially risky. The largest possible loss of a stock held long, in contrast, is 100%.

  • There is a psychological barrier: Surveys show that many U.S. investors consider shorting to be un-American and even immoral. Nothing similar applies to buying stocks.

  • Securities market regulators impose various rules on shorting. For example, circuit breakers prevent short selling on a down tick if markets have fallen a lot. But there’s no analogous restriction on buying.

  • There are institutional restrictions on shorting. Some mutual funds are not allowed to go short, for example, and some brokerage accounts do not allow shorting.

Because of these asymmetries and barriers, those who sell short have to be especially committed and confident. While that doesn’t mean they will always be right, it suggests they will be more right on balance than those who merely purchase stocks.

The best measure of short interest

Assuming you take to heart this strong message from academic research, your next step is to identify those stocks with the greatest amount of shorting. One measure on which many on Wall Street focus on is the short-interest ratio, which is calculated by dividing total short interest in a stock by it recent average daily trading volume. This metric is also known as “days to cover,” since it represents the number of days of normal trading volume it would take all the shorts to get covered.

To illustrate, consider Tesla stock at the end of November, which is the most recent date for which the Nasdaq reports data. Total short interest was 46.5 million shares, and average recent daily trading volume was 45.1 million shares. That translates into a short-interest ratio of 1.03, which is not especially high. In fact, just 12 stocks in the S&P 500
SPX,
+1.29%

 have lower short-interest ratios, according to FactSet.

You should know that this ratio does have some drawbacks. Notice that it can become higher or lower for reasons having nothing to do with short interest. If trading volume grows while short interest stays the same, for example, then the short-interest ratio will decline.

For that reason, it may be preferable to focus on short interest as a percentage of total float (publicly-traded shares). That is the metric I used to construct the table below, which shows the top 10 stocks in a ranking (from highest to lowest) of all S&P 500 stocks. If Tesla were in the S&P 500 currently (the stock is slated for inclusion in this U.S. benchmark index prior to trading on Dec. 21), it would be in 48th place, at 6.1%. That’s still more than double the average of all S&P 500 stocks, but much lower than Tesla’s comparable percentage in January, when it stood at 18.2%.

Ticker

Name

Short interest as a percentage of float

DISCA,
+0.24%

 

Discovery, Inc. Class A

+29.2%

AAL,
+1.86%

 

American Airlines Group, Inc.

+23.7%

VIAC,
+1.36%

 

ViacomCBS Inc. Class B

+21.6%

IRM,
+0.34%

 

Iron Mountain, Inc.

+18.9%

IFF,
+1.54%

 

International Flavors & Fragrances Inc.

+17.3%

NCLH,
-0.75%

 

Norwegian Cruise Line Holdings Ltd.

+16.2%

FOXA,
-0.69%

 

Fox Corp. Class A

+13.3%

WYNN,
+6.10%

 

Wynn Resorts, Ltd.

+13.0%

EXPE,
+2.16%

 

Expedia Group, Inc.

+12.7%

SLG,
+4.28%

 

SL Green Realty Corp.

+12.7%

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com

More: Tesla may be ‘most remarkable’ stock market ‘story of them all’, says strategist

Also read:  20 of analysts’ favorite large-cap stocks for 2021, including GM, Facebook and Salesforce



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‘Greed is rearing its ugly head and killing brotherly love’: My husband and his brother are at war over an inheritance from a beloved neighbor. What can we do?

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Dear Quentin,

When my husband and his only (younger) brother were growing up, a childless neighbor was very kind to them and treated them as if they were her “nephews.” They even called her “Aunt Hilda.” They also treated her like family; my husband has visited her regularly over the years. But greed is rearing its ugly head and killing brotherly love.

When my husband was away in the army 30 years ago, Aunt Hilda gave a house and a piece of property to my husband’s brother when she decided to move to another state to care for her future mother-in-law, with the written legal condition that she had a lifelong ability to return and live in the house as well, should she want to or need to.

The brother decided he didn’t really like those terms, and after living in the house for a couple of years, used the “collateral” of the property to borrow money to buy a plot of land elsewhere and build another house. The “old” house has sat vacant for 20 years, but he does the minimum to keep it from disaster. She does not stay there because it is not maintained. He has stated that he doesn’t want to do anything that will encourage her to move back into the house.


‘At first, she discussed splitting her property 50/50, then she recalled that she had already given the brother the other house and land.’

Recently, the husband of Aunt Hilda died. She is 80, and decided that she wants to write a will to leave her money and property to my husband and his brother. At first, she discussed splitting her property 50/50, then she recalled that she had already given the brother the other house and land (current value is about $400,000, no small sum).

Now Aunt Hilda says since she has already given the younger brother the other house and the land, that should be taken into consideration. The brother is sending lengthy emails to my husband trying to convince him and Aunt Hilda that the previous “early inheritance” should not be taken into consideration “because it cost him so much trouble and work.”

It is of course up to Aunt Hilda how she wants to divide up the property, and whatever that is, everybody should respect her wishes. But if she asks the brothers how to do it fairly, what do you recommend? She is 80, but she might live another 15 years and any value assigned to the brother’s house today would likely change.

There is much more that could be added as to my brother-in law’s attempts to gain more than his brother, none of which reflects well on his character. My poor husband is heartsick over his brother’s greedy behavior, especially when he should be focusing on the welfare of Aunt Hilda — who just lost her husband — and grateful that she considers to leave them anything.

Should we intervene?

The Wife

Dear Wife,

Your brother-in-law is a lot of work and his inherited property is a lot of work. In that sense at least, as God made them, he matched them.

Your brother-in-law could be less self-centered and more compassionate, and it wouldn’t do any harm if he had one charitable bone in his body. But that is not who he is, and trying to wish him to be someone other than himself is an exhausting and ill-advised endeavor. Accept him for who and what he is, and you will both enjoy more peaceful nights as a result.


Remember, if one crazy person wants to have a fight with you, and you finally relent, there are two crazy people in that fight rather than one.

Your husband regards Aunt Hilda as a beloved relative and her estate as a gift, while his brother sees her estate as a lemon that can be squeezed time and again. What would I say to his brother? “The property required a lot of work over the years, and you have benefited from the property over the same amount of time. You chose to accept this inheritance early, and it has worked out very well for you.”

If he continued to make waves? I would feel compelled to tell him that it’s just plain unreasonable to constantly push for more. The love and care he lavished on his own property has been in direct proportion to the lack of care and duty bestowed upon Aunt Hilda’s home, and for all the years he enjoyed this property, she did not. You have to be prepared to stand up for what you believe is fair.

And remember, if one crazy person wants to have a fight with you, and you relent, there will be two crazy people in that fight rather than one. For that reason, advise Aunt Hilda to hire an estate attorney to draw up the papers fairly and squarely. Lawyers are paid well to deal with difficult personalities, and they have a duty to make sure their client’s wishes are upheld.

You can email The Moneyist with any financial and ethical questions related to coronavirus at qfottrell@marketwatch.com

The Moneyist: ‘Warren Buffett and Harry Potter couldn’t get those two retired early’: Our spendthrift neighbors said our adviser was ‘lousy.’ So how come WE retired early?

Hello there, MarketWatchers. Check out the Moneyist private Facebook
FB,
+0.16%

 group where we look for answers to life’s thorniest money issues. Readers write in to me with all sorts of dilemmas. Post your questions, tell me what you want to know more about, or weigh in on the latest Moneyist columns.



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Opinion: Higher interest rates could mean more cash for seniors

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Here’s a common complaint I hear from seniors all the time: Interest rates are so low that it’s impossible to earn enough cash to supplement Social Security.

“Certificates of deposit don’t earn anything,” writes MarketWatch reader Camille: “Until the mid-2000s, you could easily earn 4% on a certificate of deposit (CD). Today, your money does not earn anything, which penalizes small savers and seniors.”

She’s right. Based on rates as I write this, if you put $500 into a one-year CD, you’d get back about $502.76 in 12 months. Wow! Two whole dollars and 76 cents! Probably enough for a loaf of bread or a gallon of gas, but not much else.

Low interest rates are a double-edged sword. If you’re borrowing money, it’s obviously good, but if you’re trying to make a few bucks, no. And this isn’t likely to change in any significant way, given the Federal Reserve’s recent announcement that it plans to keep its key “Fed Funds” rate low until the economy and jobs market picks up steam.

Since things like money-market funds and certificates of deposits are tied to the Fed, that’s tough news for anyone hoping to squeeze more out of their savings.

Meantime, those paltry returns stand in contrast to things that keep shooting up, like the cost of healthcare. I recently reported that drug prices, for example, are rising much faster than inflation, and much faster than the cost-of-living adjustment that seniors typically get from Social Security.

This one-two punch—more money going out and less coming in—is punishing seniors, pushing many closer to, if not into, poverty.

The need to earn more has nudged some seniors into the stock market, which in and of itself isn’t necessarily bad; financial advisers typically say that given the possibility of decades in retirement, even seniors should have some exposure to equities. But with stocks at nosebleed levels—the price-to-earnings ratio on the S&P 500
SPX,
+1.14%

 is up 80% from a year ago—caution abounds. As usual, I’ll emphasize that how much a retiree should have in stocks depends on factors like age, risk tolerance and so forth, and is best discussed with a trusted financial adviser.

It’s often tempting when rates are super low like now to put cash into things with fat dividends, but “you have to be very careful,” cautions Andrew Mies, chief investment officer of 6 Meridian, a Wichita, Kansas-based wealth management firm. “Saying I’m going to go buy a high dividend-paying stock or MLP (master limited partnership, an investment vehicle common in capital-intensive businesses, like the energy sector) were disasters in 2020. Buying high-dividend stocks was one of the worst performing strategies you could have had last year, and some MLPs were down 30-40%.”

In other words, what’s the use of buying something that pays a dividend of 8%, 9% or more—only to see the stock itself plunge by a third? One market strategist, the late Barton Biggs of Morgan Stanley, once said “More money has been lost reaching for yield than at the point of a gun,” and he was right. Echoing that is none other than Warren Buffett, who has called reaching for yield “stupid,” but “very human.”

So what to do?

Mies urges something that many people have trouble with: Patience. That’s because rates, all of a sudden, appear to be moving higher, and if you can wait a bit, you just might be able to find safer investments that yield more than you might be able to get now.

He’s right. As of Friday, the yield on the 10-year Treasury bond stood at 1.34%, hardly robust, but up from 1.15% for the week. Two things to remember here: When bond rates go up, bond prices go down; higher bond yields can also make stocks less attractive on a relative basis as well.

Mies thinks rates will continue to climb. “I think you’re going to have a chance in the next 12 months to put money to work at higher interest rates.” Buying or selling are choices, but so is doing nothing, so “I do think that not getting aggressive right now is probably the most prudent action.”

And after rates go high enough, he thinks municipal bonds could become more attractive, corporate bonds could, Treasurys could. “There will be pockets of opportunity that pop up.”

You may want to consider what have long been considered so-called “widow and orphan” stocks: utilities. “Utilities have been trading as if the 10-year (Treasury) is significantly higher than it is. That could be a spot worth dipping your toe in.” Possibilities to consider—preferably in consultation with your financial adviser—include the Standard & Poor’s Utilities Select Sector Fund
XLU,
-1.17%

and iShares’ Global Utilities ETF
JXI,
-0.54%
.
XLU currently yields 3.3%, while JXI yields 2.78%, certainly more than those measly rates found in CDs or money-market funds.



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Opinion: Few 401(k) participants changed portfolio allocation when market tanked

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The rumor has been that 401(k) participants took little action when the stock market declined by more than 30% in February and March 2020. A Morningstar study provides some numbers to back up the lore.

The data come from a major record-keeper for defined-contribution plans. The starting point was snapshots for two dates: Dec. 31, 2019 and March 31, 2020. To be included in the analysis, the participant had to show up in both samples. That is, they had to be enrolled on or before Dec. 31, 2019 and still in the plan March 31, 2020. This construct ensures that observed changes reflect active decisions by participants as opposed to the sponsor replacing one fund with another. The final sample consisted of 635,116 participants across 509 plans.

The important finding is that only 5.6% of participants enrolled as of Dec. 31, 2019 changed their portfolio allocation during the first quarter of 2020. Participants who adjusted their portfolios changed their equity allocations. Most of these changes were relatively small, with an average equity reduction of about 10 percentage points. However, older participants who changed their accounts made larger changes than younger participants, particularly if they were invested more aggressively.

Much of the report goes on to look closely at the 5.6% who did move their money. For this exercise, the report identifies four types of participants: self-directing their accounts, using a target-date fund, defaulted into a managed account, and opted into a managed account. The pattern across participants shows that those with professionally managed solutions — target-date funds or managed accounts — were much less likely to change their allocation.

On balance, this report seems like good news. Buying high and selling low doesn’t end well.



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