Short sellers flocking to U.S. banks risk getting squeezed if investors decide to fight back

Article content

Crowded equity trades and possible policy remediation for U.S. regional banks may bring an end to a trade that’s roiled broader markets but proved lucrative for some short sellers.

Article content

After implosions of institutions such as Silicon Valley Bank and First Republic Bank set the market on edge, the rout deepened on May 4, with the KBW Regional Banking Index extending this year’s decline to 31 per cent. Fuelling the losses was a report that PacWest Bancorp is exploring strategic options.

Article content

That’s music to the ears of traders speculating the woes will worsen. Betting against regional lenders has netted about US$7 billion in paper profits so far this year, S3 Partners research found, as higher interest rates triggered liquidity concerns and led to the banking turmoil.

Still, regulators have so far been able to deal relatively quickly with the banks that ran into trouble. What’s more, analysts say that pockets of the market are looking ripe for buyers to fight back.

Article content

Article content

Lawyers at Wachtell, Lipton, Rosen & Katz, for example, urged the Securities and Exchange Commission to impose a 15-day prohibition on short sales to give time for work on restoring confidence. The commission said it wasn’t currently considering a short-selling ban.

Fundstrat technical strategist Mark Newton said regional banks might be making a “short-term bottom” May 5 on signs of seller exhaustion, partially based on DeMark signals, a type of technical indicator that attempts to identify turning points in markets.

Here’s what strategists are saying:

Chris Murphy, co-head of derivatives strategy at Susquehanna International Group

“While it’s hard to see a catalyst to turn around the regional banks right now, it is a very popular and very crowded short which might be due for a squeeze at some point. Earlier today, we highlighted call spread buying in the SPDR S&P Regional Banking ETF.”

Article content

Tom Lee, head of research at Fundstrat

“We are arguably reaching a point of hysteria. For instance, Pacific West Bancorp (Ticker: PWBK) had to issue a press release and on its website state that it is not PACW (PacWest Bancorp) — and after falling five per cent, managed to close the day higher. Similarly, Republic First Bancorp had to issue notices that it is not First Republic and after seeing its shares fall 20 per cent managed to close down only five per cent. And there are some suggesting that 0DTE (zero days to expiration) options and short-term speculators are adding to pressures.”

Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets Corp.

“It’s getting to the stage where the trajectory of negative headlines implies the slow-motion series of bank failures is the consensus.”

Tony Dwyer, chief market strategist at Canaccord Genuity LLC

“The financial media and traders continue to focus on the ‘systemic’ side of this, but – as we have said since day one – the much more important factor is how the uncertainty further pressures money availability and tightens Bank Lending Standards and overall Financial Conditions.”

Bloomberg.com