The market has returned to its starting point for the year, but major changes have happened underneath. S&P short interest has jumped, and sector rotation is clear. Short sellers are focusing on both the top and bottom performers, skipping the middle.

The market has returned to where it began at the start of the year, a dramatic opening that ultimately brought us full circle.

While one might argue that “nothing happened” since the market is back where we started, this view overlooks the significant shifts beneath the surface.

S&P short interest has risen substantially, rising by almost $100 billion. Shorts that were put on at the bottom have not been covered.

The large short increase occurred while the S&P 500 was near its highs, suggesting growing bearish sentiment despite market strength, or anticipation of a sell-off.

Besides the change in short position, there has been sector rotation in index returns YTD.

Leaders (up 7% or more YTD): Industrials, Utilities, Financial.

Moderate Decliners: Energy, Health Care, Cyclicals.

Moderate Gainers (up 4–5% YTD): Staples, Communications, Materials.

The increase in short interest is not evenly distributed across sectors.

The largest increases are seen in Discretionary, Health Care and Industrials.

A linear regression of year-to-date sector returns vs changes in short interest shows a very weak relationship.

However, a scatter plot reveals a non-linear, curved relationship:

Sectors with the largest positive and negative returns saw the greatest increases in short interest.

This suggests that short investors are shorting both the winners and the losers, while largely ignoring middle-performing sectors.

In conclusion, the market’s unchanged surface masks deeper shifts. Rising short interest and sector rotation reflect complex investor behavior. The focus on both outperformers and underperformers highlights a nuanced and strategic approach to risk and positioning.

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