Assessing Bearish Strategies in US Equities: Economic Resilience and AI Enthusiasm

Key Takeaways

• The underlying strength of the US economy and robust consumer spending.
• Increasing investment in Artificial Intelligence as a driver of productivity growth.
• Market volatility and its impact on short-selling strategies.
• The Federal Reserve's anticipated stance on interest rate cuts.
• The seasonal bullish tendency of stocks in December.

Strategists at 22V Research suggest that anyone looking to short US equities this month should carefully consider the resilience of the American economy and the continued fervor surrounding artificial intelligence. They posit that increased consumer spending and AI investments could bolster productivity, enabling companies to drive stock prices higher through robust earnings.

These remarks come at a time when US equities have experienced heightened volatility, with investors concerned about the impact of tariffs on the economy and monetary policy, as well as the perceived disconnect between AI investments and profitability. After briefly falling 5.1% from its October all-time high, the S&P 500 staged a rebound last week, highlighting the risks associated with shorting a highly volatile market.

Dennis Debusschere, co-founder and chief market strategist at 22V, leading the strategist team, emphasized that "shorting at these levels requires high conviction in a material weakening of the economic backdrop or a significant change in the outlook for AI capital expenditures."

According to data compiled by S3 Partners LLC, short-sellers of US equities suffered $80 billion in mark-to-market losses in the final week of November, a decrease of approximately 4.8%, erasing most of the nearly $95 billion in cumulative profits earned in the preceding month. Ihor Dusaniwsky, Managing Director of Predictive Analytics at the firm, commented, "Shorts experienced a rollercoaster ride in November, giving back almost all of the profits earned in the first three weeks during the last week."

Prime brokerage data from Goldman Sachs reveals that hedge funds have recently increased their short covering of US equity indexes and exchange-traded funds (ETFs) to the highest level in five months.

Despite the turbulent trading following the strongest six-month rally since the 1950s, fundamentals continue to defy skeptics. Data from Strategas Asset Management LLC indicates that corporate profits are projected to grow by 12.5% over the next 12 months. While consumer confidence has been waning, Mastercard SpendingPulse data showed a 4.1% increase in spending during Black Friday compared to last year, suggesting continued strength in the US consumer despite labor market weakness and inflation concerns.

The Federal Reserve is expected to initiate interest rate cuts at its upcoming policy meeting, a move that should stimulate economic activity. Within 22V, a model tracked by the quant team has shifted into an "everything rally" mode.

After a frenzied 3.7% surge in a holiday-shortened week, salvaging November's gains, the S&P 500 fell 0.5% on Monday. Since April, whenever the market has dipped, dip buyers (whether retail or institutional investors) have almost invariably emerged, regardless of the macro backdrop.

“It’s extremely difficult to short stocks right now because any market weakness is always met with a reflexive buying reaction,” said Dave Mazza, CEO of Roundhill Investments. “The dramatic turnaround in November from one of the worst months in decades to a positive-gains month forced shorts to cover.”

The wild surge of nearly 37% in Beyond Meat Inc. on Monday without any apparent news fully illustrates the risks; this stock, which traded above $190 in 2021, had fallen to $0.52 in mid-October. It then rebounded nearly seven-fold in three days before falling again. Speaking of Beyond, Mazza said, “The cost of holding a bearish position goes up very fast.”

Traders are also entering a seasonally bullish period for stocks. LPL Financial data shows the S&P 500 rises an average of 1.4% in December and closes higher 73% of the time, the highest win rate of any month. This strength typically emerges in the second half of the month, with upward momentum often beginning to build around the 11th trading day.