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Tech short sellers poised for rotation as vaccine buoys value stocks

Tech short sellers are still waiting for their pay day.

Short interest in U.S. communication services stocks rose to 4.7% at the end of October, leaving them third among the 11 S&P 500 sectors, behind only consumer discretionary and healthcare, the latest S&P Global Market Intelligence data shows. Bets against those companies have risen by 1.3 percentage points since the end of March, the most of any sector during the pandemic.

Those wagers are yet to pay off. While technology stocks have had a few bad days of late, the S&P 500 Communication Services index, which features the likes of Facebook Inc., Alphabet Inc. and Netflix Inc., has still managed a gain of 9.1% this month through Nov. 16, only slightly worse than the broader S&P 500 index, which is up 10.9% in the same period.

Short sellers are increasing their positions in technology companies after the sector drove equities' recovery from the pandemic, helping the S&P 500 to repeated records since August. The Communications Services index has risen 19.5% this year, compared with 12.3% for the broader gauge.

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Short interest in communication services stocks is expected to continue to climb as investors rotate out of search and social media stocks, such as Facebook and Alphabet, and toward value stocks on positive news of a coronavirus vaccine, said Tom Essaye, a trader and founder of The Sevens Report.

However, while some of the stocks that were most hurt by the pandemic have outperformed many of those that benefited from the restrictions that have been in place for much of the year, the so-called rotation is yet to result in a sell-off of this year's winners.

"Communications services will likely struggle on days when the rotational trade goes against them," said Edward Moya, a senior market analyst with OANDA. "Tech and innovation are required for the broader market rally to continue, but it seems with current valuations in place that the tech rally needs a breather."

"I think we're seeing shorts try and anticipate the rotation out of tech … and into value due to the vaccine," Essaye said in an interview.

The S&P 500's communications services sector finished Nov. 16 up about 0.6% from Nov. 13 after the S&P 500 closed up nearly 1.2% on the day at a new all-time high after Moderna Inc. announced its coronavirus vaccine showed 94.5% efficacy in interim results from a phase 3 study. Since Pfizer Inc. and BioNTech SE announced Nov. 9 that their COVID-19 vaccine was found to be more than 90% effective at preventing infection in interim data from a late-stage clinical, the S&P 500 has twice closed on a new record high and has risen by more than 3.3%.

The Pfizer announcement ignited an initial rotation from growth stocks to value stocks, but the rotation fizzled later in the week as investors braced for more lockdowns as coronavirus cases surged to new records.

The Moderna announcement reignited that rotation, however, as the S&P 500 Value index increased 1.7% on Nov. 16, compared to the S&P 500 Growth index, which increased by 0.8%. Since the start of March, when the impacts of the pandemic began in the U.S., S&P Growth has increased by 33.9%, compared to S&P Value, which has increased by 9.3%.

"Every incremental COVID-19 vaccine update has investors continue to play tug-of-war with value and growth stocks," Moya said.

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Short interest averaged just under 5.8% in the consumer discretionary sector at the end of October, the data shows. The sector remained the S&P 500's top shorted sector, as it has been throughout the pandemic, but the average has fallen since the start of the pandemic. In mid-March, short interest in consumer discretionary stocks averaged over 6.5%.

Investors believe that surging U.S. coronavirus cases and a lack of movement on a new government stimulus effort will cause a tumble in consumer discretionary stocks, a situation unlikely to improve in the near term, said Essaye.

"The partial lockdowns spreading across the country will put downward pressure on personal finances of those impacted, and meanwhile its unclear when Congress will pass a stimulus bill — but it's looking like early 2021 at the earliest," Essaye said.

Short interest in healthcare stocks was at about 5.3% at the end of March, down about 0.7% from where it was in late March, but still the second highest short average of any sector.

"Healthcare might have a tough time as picking the winners against COVID-19 appears to be almost over," Moya said. "These healthcare giants will likely see limited profitability as government programs such as Operation Warp Speed will not allow companies to profit dramatically."