Hedge funds squeezed as shorts beat S&P 500 by most in year

’Risk-On Mode’

Stocks started off 2013 with a bang, as the S&P 500 climbed 4.6 percent to 1,466.47 last week, the highest since December 2007. Equities had the biggest two-day rally in a year on Dec. 31 and Jan. 2 as U.S. lawmakers agreed on a plan that averted tax increases even as Obama fell short of reaching a larger deficit-reduction bargain with Republicans. They extended gains after the Labor Department said the U.S. added 155,000 workers last month, compared with the 152,000 median estimate of 82 economists surveyed by Bloomberg.

“We’re now in a risk-on mode, which means short covering of the most-shorted stocks,” Steve Shafer, the chief investment officer at Covenant Global Investors, an Oklahoma City-based hedge fund that manages $330 million, said Jan. 2. “It’s probably a good sign because it means people expect this move to persist.”

Short sellers, who borrow securities and sell them expecting to buy them back at a cheaper price, provide only a temporary lift for benchmark gauges because abandoning their bets soaks up a pool of potential demand, said Tom Stringfellow, president of San Antonio-based Frost Investment Advisors LLC, which manages about $9 billion.

‘Not Sustainable’

“The risk is that if this market rally has been based on short covering and that was all it was, then there’s no further money following,” Stringfellow said by phone on Jan. 2. “The rally is then either dead or not sustainable.”

Congress must agree to raise the federal debt ceiling as soon as mid-February to prevent a U.S. government default. Negotiations over the borrowing threshold in 2011 led S&P to strip the U.S. of its AAA credit rating and pushed U.S. stocks within 1 percentage point of a bear market.

At the same time, estimates of how much American companies earned in 2012 are falling. Combined S&P 500 profits were probably $103.40 a share, according to more than 10,000 forecasts compiled by Bloomberg on Dec. 31. That compares with $105.20 a share on Oct. 15. Alcoa Inc., the largest U.S. aluminum producer, is due to begin the fourth-quarter earnings- reporting season when it releases results this week.

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