In a moment of weakness over the holidays, and maybe some FOMO, I got a new puppy.

I love dogs as much as the next person, but I had been loath to add the responsibility. Then:

1. My neighbor said “it brings so much joy” and

2. Since my parents never relented on my own numerous requests for a dog growing up, it’s fulfilling my inner child.

And Alfie is super cute. 

I realized too that this is a life example of capitulation. A term often used in investing describing when someone’s investment view has been the opposite of what the market has been doing for a while, and they eventually throw in the towel to go along with the markets. I’ve seen it happen more often to a bear watching the markets roar higher, but it can happen to a bull when markets fall pretty deeply.

Something that can cause an investor to give in to the market, in the short term, is the direction of what’s called short interest. There’s been some chatter recently about short covering in markets. But to back up for a second, shorting a stock means an investor, who thinks a stock could fall in value (or at least won’t perform as well as others), sells borrowed shares hoping to repurchase them at a lower price if the value drops. 

The general approach to shorting stocks is, and probably should be, different to buying stocks. This is because unlike buying a stock, when shorting a stock, there is no theoretical limit to losses. The higher a price goes, the more one would lose. This can mean that time is not always on the side of a short seller (where it can be for an investment buyer). As a result, investors shorting stocks that do see a fall in value, may take those profits more quickly—buying back the shares and returning them.  

According to the Finra equity short interest data, short interest increased on average, from mid December to the end of December. And since there are more small cap stocks shorted, on average, than large cap stocks, it seems reasonable that the Russell 2000 index (a small cap index) rallied during the last few days. With broad markets down for the first week or so of 2024 and small cap stocks down more, there may have been some short covering there (meaning buying to close short positions) to take profits.

For a long term investor, considering whether a stock is shorted isn’t really a reason to invest or not. But, looking at the outstanding short interest (such as the % of outstanding share, or “float” that is shorted, or number of days to cover) can be an indicator to see how loved or hated a stock is. If it has a higher short interest and an investor thinks a stock is undervalued, it can mean the stock could rally more strongly if they turn out to be right. That’s because those selling a stock short, may buy the stock to close out their position and stop losses. But again, this data is a tool rather than a reason to invest. 

And remember, it’s earnings season now too, which can whip stocks around quickly as well—especially because, in my view, expectations for earnings growth are elevated. This week and next are the biggest weeks in the earnings season, where 58% of the market cap of the S&P 500 will be reporting:

So, in short, investing comes back to the fundamentals—know the details of what you own, and pay attention to the earnings of your stock investments. You’ll likely never have to capitulate away from these foundations.