Short sellers are raking in profits by betting against a part of the US equity market overlooked by most investors: small-cap stocks.
The group has seen paper profits of nearly $13 billion this year by wagering on a drop in the prices of small-, micro- and nano-cap shares, according to an estimate by S3 Partners LLC based on the average amount of short positions in the market. That’s in stark contrast to the roughly $140 billion in losses from short sales of mid-, mega- and large-cap stocks, which rallied for much of the year as the economy defied gloomy forecasts, the Federal Reserve edged closer to ending its interest-rate hikes and breakthroughs in artificial intelligence triggered a stampede in tech stocks.
The difference underscores the gulf that opened up in the stock market as companies like Nvidia Corp., Meta Platforms Inc. and Tesla Inc. drove much of the gains. More than half of the stocks in the Russell 2000 — a gauge of smaller companies — have dropped this year, holding it to a 5% gain, far below the 16% jump in the S&P 500.
“So much of this year’s performance has been about AI enthusiasm, which disproportionately benefitted the largest tech stocks,” said Steve Sosnick, chief strategist at Interactive Brokers. “It’s been a top-down set of winners so far.”
The small-caps stocks joined in the equity-market rally from June through July. But they’ve been hit hardest during the recent pullback, with about $9.7 billion of short-sellers’ estimated profits emerging since August, according to S3’s data.
With the shares battered, investors withdrew $1.5 billion from funds focused on the segment last week, the most in nearly three months, according to Bank of America Corp. strategists, citing EPFR Global. By contrast, US large-cap stock funds pulled in $5.5 billion.
One reason for the underperformance is sector weightings that have curbed interest as investors focus heavily on particular industries,…