Short interest in the Aerospace & Defense Sector has sky-rocketed in 2018, with short exposure hitting $17.7 billion by March 19th, an increase of 29% for the year. Since then, short interest has declined by $2 billion as shorts covered over $1.5 billion of short exposure in United Technologies (UTX), Lockheed Martin (LMT) and Honeywell (HON).
Aerospace & Defense continues to be the most shorted industry in the Industrial Sector with a total short interest of $15.7 billion, making up 20% of the $79.7 billion worth of short exposure in the sector as well as being the tenth most shorted industry in the U.S. This increase in short selling occurred despite the growth in domestic defense spending, and increased demand for aircraft engines and parts, aerospace systems and fuel cell technology which has spurred the sector to outperform the overall market in 2018, with the S&P Aerospace & Defense Index up 8% for the year.
But recently, even with the threat of the U.S. implementing trading sanctions against both China and Russia and the expected reciprocal sanctions which will be levied against our industrial and agricultural complex there has been a reduction of short exposure in six of the top ten most shorted stocks in the sector since March 19th.
Short sellers in the Aerospace and Defense Sector seem to be discounting the negative effects of potential sanctions and tariffs and instead are focusing on the longer term positive effects of an increase in overall federal spending on defense modernization, cyber warfare and missile/drone advancements. In addition, a strengthening U.S. economy should spur non-federal spending in the areas of aircraft purchases; airplane parts and engines; electronics and information systems.
Short interest in the sector looks to have fallen off of recent highs and plateaued around the $15.75 billion level after increasing steadily since the third quarter of 2017. If the sector continues to outperform the S&P 500 we may see continued short covering and short interest revert back to the $11.0-$13.5 billion range seen in 2016 and the first three quarters of 2017. If shorts do begin to trim their exposure, there may be over $2 billion of buy to covers, over time, boosting Aerospace and Defense stock prices to even higher levels.
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Managing Director Predictive Analytics, S3 Partners, LLC
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