First the Internet and now biotech. Short-sellers, finding fewer and fewer places to hide, have started covering like cornerbacks.
Short interest, or the proportion of shares borrowed for the purpose of betting on a stock's decline, has been tumbling marketwide. But the shorts have been even quicker to get out of biotech, even though the sector has long furnished skeptics with a reliable stash of heavily hyped pipe dreams. Biotech was one of the most active areas of covering for short-sellers in January: Of the 25 most-covered shorts last month, six were biotech companies. The only industry with comparable short-covering was the Internet.
In contrast to previous years, the shorts are covering stocks on which they've taken a beating. That's leading some investors to wonder: if not biotech, then where? The shorts have already been run out of the Internet and run out of the big-caps, which have dictated new valuation parameters above historical averages virtually across the board.
Salomon Smith Barney's
equity strategist, suggests that the shorts' departure "leaves a bit of a vacuum. It means part of the buying is artificial. It's buying by the shorts." He adds, "It's also a sign not of euphoria -- it may be -- but that the bears are really scared, which is the equivalent of euphoria."
The recent pattern of covering is unusual, says Mike Long of
, a Charlotte, N.C., service that tracks short sales. Historically, he says, as stocks went up, shorting went up. When stocks went down, shorts covered, or bought shares to replace the borrowed ones. Sell high and buy low. Now, even as the market averages hover near all-time high levels, shorting is on the decline.
Shorting is becoming rarer in general. Open interest on the
Nasdaq Stock Market
has fallen every month save one since it hit a record of 2.17 billion shares in July. In January, there were 1.87 billion shares shorted. On the
, short interest hit a record of 4.2 billion shares in September and has steadily fallen to 3.65 billion as of late January.
The story of the defeat of the shorts has been written many times over this long bull market. The stories have a triumphal air, as if bad and wrong thinkers have been purged. But those accounts fail to ask: Who will offer the checks and balances and skepticism that help the market stay rational? Who will provide the "wall of worry," now as fabled a creature as a Gryphon?
"Fear goes both ways. A bull's greed is a bear's fear," says Manley. "People are overwhelmed by momentum."
In health care in general, shorts are running to cover. In the 50 most heavily shorted companies, short interest fell to 143.4 million shares in January from about 190.5 million at the July peak, according to
Sturza's Medical Research
, a boutique research shop.
"If you look across the board at all the names, people are pulling up their tents and saying, 'Let's move on,'" says Evan Sturza, who heads the firm. He says the short interest in healthcare is the lowest in about two years.
The shorts aver.
"People are saying, 'It's not an even playing field. I'm getting screwed even when I'm right on the fundamentals,'" says David Tice, who runs the
can be at $75, no price is too high for XYZ biotech," Bill Fleckenstein, a well-known short-seller, says of a stock that has become a point of contention between shorts and longs. But he insists that shorts haven't been wrong: "I don't know if it's capitulation. There's a distinction between capitulation, which is admitting you've gotten the story wrong, and a tactical covering, which allows you to fight another day."
In biotech, the state of affairs marks a stunning turnaround from September. Then, biotechs had hit an iceberg. The stocks had sunk and shorts were enjoying their salad days. Since then, of course, the market has come back, stronger and faster than anyone had forecast. Biotech has been one of the strongest sectors, with the
Amex Biotech Index
up about 87% since its lows in August, far outstripping a paltry (by comparison) 33% gain for the
It's in this context that the shorts started to cover. Further, the type of covering is worrisome too for the shorts. Almost all the heavily covered names are highfliers.
Biotechs tend to rise in the autumn and through January, thanks to a series of scientific meetings and investor conferences that shine attention on the group. But this recent covering doesn't appear to be part of a seasonal adjustment. Five of the six highly covered companies are at or near their highs. By contrast, there were no biotech companies among the most heavily covered in January 1998. There were three medical technology companies, which are similar to biotech companies by virtue of their heavy development costs, high risk and rigid regulation. The stocks of those three companies had fallen, marking a victory for the shorts.
This year, the shorts are losing. They're covering on companies whose shares have risen steadily since the Aug. 31 bottom: All six are up more than 50% since then.
, the second most covered company overall in January, has climbed about 168%. Other heavily covered biotech firms include highfliers like
, up 133%,
, up 105%, and
, up 185%.
Manley at Salomon Smith Barney says the covering isn't a clear sign of the top. He says there never is such a thing. But he adds, "Clearly, there's some euphoria. You see it from the buying side and in the fear from the bearish side." And that means that if the stocks fall, there may be no one to buy them.