FT Alphaville had another solid post yesterday, this time trying to assess whether short covering was higher or lower than normal during the most recent rally. They plotted a chart showing the Goldman Sachs short interest basket (an equally weighted basket of the 50 most highly shorted names in the Russell 3000 index) vs. the Russell 3000 and the S&P 500 indices:
As you can see from the graph, the high short interest names have substantially underperformed since the beginning of 2012. The underperformance has widened on the most recent rally. As FT Alphaville also question, it’s hard to decide what to make of this underperformance. Does that mean that there is a lower short base to start this year vs. the prior 2 years , that the fundamental divergences have widened between the worst companies and the best companies, or some other reason that high short interest names are underperforming?
Regardless of the answer, I view it as notable evidence that finding the weaker stories on an individual stock basis has been a better way to find protection than broad index puts, which is generally the product of choice in managing large portfolio downside risks.