In the second quarter of this year, U.S. stock short sellers made a lot of money. Although the overall market continued to rise, they still successfully shorted a portion of U.S. stock targets.

Short sellers made $10 billion in paper gains in the second quarter, according to S3 Partners LLC. Paper gains in sectors such as industrials, health care and financials offset $15.7 billion in mark-to-market losses in the technology sector, said Ihor Dusaniwsky, managing director of S3’s predictive analytics division.

“This quarter, they really did a great job picking stocks,” Dusaniwsky said, noting that IBM Companies such as IBM (IBM.US) and Cloudflare (NET.US) saw solid trading performance, but their share prices fell in the second quarter.

The ability of short sellers to profit as the market rallies suggests that investors are flocking to a handful of big tech stocks amid an uncertain macroeconomic backdrop, while some areas of other industries are weak.

The S&P 500 rose 3.9% in the quarter ended June 28, with Nvidia Corp. (NVDA) up nearly 37% and the tech-heavy Nasdaq The 100 index rose 7.8% during the same period.

“The narrative has been that the market is too narrow,” said Quincy Krosby, chief global strategist at LPL Financial. “There’s a growing consensus that the time is running out for these stocks to be the only ones to rise.”

There is evidence that short sellers are pouring money into sectors that rose in the second quarter. These contrarian traders poured $33 billion into the information technology sector, according to S3, and as those stocks rose, they took large short positions in Google. Parent company Alphabet (GOOGL.US), Meta Platforms (META.US) and Netflix (NFLX.US).

The traders also aggressively increased bets on underperforming sectors, including financials, consumer staples and consumer discretionary. (TSLA.US) is an exception - although most short sellers are heavily shorting the consumer discretionary sector - these short sellers exited their trades by covering their shorts, or buying back shares, amounting to $2.2 billion, which caused Tesla to drop from first in the ranking of the most shorted stocks in 2023 to fourth this year.

Meanwhile, the energy sector saw the most short covering in the second quarter.

Dusaniwsky attributes the shorts’ success to taking market momentum into greater account when deciding how to trade.

“Market liquidity is almost more important than the fundamentals of the company,” he said. “We are seeing more longs and shorts flowing into the market than in the past.”

Of course, this momentum could turn quickly, and Krosby warned that a transition is coming. Second-quarter earnings reports are coming soon, and any news that the tech giants miss expectations could quickly cause their stock prices to fall. The Federal Reserve and when it cuts interest rates is also one of the variables. In this context, "you have to be very careful," Krosby said.

.