Late last week, I spent a few minutes editorializing around record-low short interest on the two most prominent US equity index ETFs.

The inexorable decline in wagers against those products is a contributing factor to a multi-faceted feedback loop driving the indexes higher and index vol lower.

JPMorgan’s Nikolaos Panigirtzoglou described a self-fulfilling prophecy whereby short covering lends support to the benchmarks and suppresses volatility, which in turn squeezes out more shorts and triggers buying from vol-sensitive investors in a virtuous circle.

Panigirtzoglou also wondered, on clients’ behalf, if declining short interest at the index level reflected rising short interest at the individual stock level. The answer, he said, is “no.”

Equally-weighted average short interest on the market leadership (i.e., the “Magnificent 7”) and for the equally-weighted index are both low and haven’t increased meaningfully in years.

In explaining why and how shorts were driven out, Panigirtzoglou cited three factors. To wit:

1. It has become more difficult to sustain short positions in a steeply rising US equity market
2. By mandating transparency in short selling, regulators have been making shorting equities more costly for short sellers as they become more likely to be squeezed out of their positions by other players
3. The more active engagement by US retail investors in stock trading post the pandemic and in particular the meme stock frenzy of January 2021 has deterred short sellers

While not exactly groundbreaking stuff, this is at least worth mentioning in light of the never-ending melt-up in equities.

Panigirtzoglou also pointed to declining AUM in short-bias equity funds. The figure below uses HFR data to give you a sense of the situation.

To state the obvious: It would appear that AUM is still quite elevated relative to pre-pandemic.

In keeping with the bank’s house view — which remains cautious and defensive unless something’s changed over the past 72 hours — Panigirtzoglou offered a warning of sorts.

“Coupled with high equity allocations by real money investors and elevated equity futures exposures, the low short interest and declining AUM of short bias hedge funds signal a heightened vulnerability to negative news,” he said.

Thankfully, we live in a world where most news is good news, and negative news is a relative rarity. Unless you count the wars. And the inflation. And the famine. And the inequality. And the dying biosphere.