Record highs continue to be the theme on Wall Street as 2018 gets underway. Investors have shrugged off a bond rout and a government shutdown, and continue to pile into U.S. equities, which have seen all three major indices notch further milestones. The Russell 3000, which measures the total value of U.S. equities, is edging towards $30 trillion, and the good times are not just here in the U.S.: global stock market value increased to $9 trillion in 2017. 

However, as records continue to tumble, investor skepticism remains. Short interest among the three largest ETFs in the U.S. increased by $2.3 trillion, during the week ending January 19, including the Spider S&P 500 (SPY) that saw an additional $1.8 billion of shorts, according to S3 partners, a financial analytics firm. 

Why So Many Shorts?

Short interest among the three largest ETFs – the SPY, the iShares Russell 2000 (IWM), and the PwrShares Nasdaq 100 (QQQ) – total $61 billion, and with equities notching record levels on a daily basis, why are there so many shorts? One hypothesis: hedging. 

For large institutional investors with exposure across many asset classes, and a wide range of equities, these three ETFs provide an easy tool to hedge any potential downside risk. The three ETFs are a bellwether for global equities, which makes them a perfect hedging tool for diverse portfolios. Furthermore, they provide adequate liquidity (SPY AUM totals $292 billion with daily turnover of $18 billion, according to data from FactSet) that give investors cheap entry and exit strategies through small spreads. (See also: How To Prevent Your Stock Gains From Vanishing.)

The Bottom Line

While shorting of individual stocks can indicate general pessimism, shorting of large ETFs can tell a different story. With large daily turnover and strong correlation to overall sentiment, these ETFs provide an ideal tool for hedging against unforeseen events and market sell-offs.

However true this may be, not all short interest in the ETF market is hedging. With each stock market record, another analyst emerges calling the top of the decade-long bull market. Whatever camp you're in, just remember what John Maynard Keynes said: "The market can stay irrational longer than you can remain solvent." 

 

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