Hedge funds, whose bearish bets on stocks have held their returns to half the Standard & Poor’s 500 Index in 2013, pushed short sales close to the highest level of the year just as the U.S. budget impasse spurred a doubling in volatility.

Rising bets against equities sent a gauge of manager bullishness compiled by ISI Group LLC within 0.2 point of its lowest reading in 2013 last week. Short sales have backfired as the S&P 500, up 19 percent this year, posts one of its broadest rallies on record. The index lost 0.5 percent to 1,694.17 at 10:07 a.m. in New York, paring the biggest two-day rally since January as lawmakers struggled for an accord to raise the debt ceiling. It has swung an average of 0.82 percent a day in October, compared with 0.45 percent in the third quarter.

The embrace of bearish trades has squeezed returns for professionals and is one reason stocks have repeatedly rallied in 2013 amid slowing economic and profit growth, according to Cambiar Investors LLC and Pension Partners LLC. Rather than falling, shares that investors have shorted the most are up 38 percent since January, a consequence of forced buying during rallies by speculators who borrowed and sold them, data compiled by Goldman Sachs Group Inc. show.

“There still are people out there who are convinced the whole market and financial system is some house of cards,” said Brian Barish, president of Denver-based Cambiar Investors, which manages about $8 billion, said Oct. 10. “I think they wind up shooting themselves and their investors in the foot with the permabear mentality, but it persists.”

‘Productive Conversation’

Senate leaders struggled to draft an accord over the weekend that averts a U.S. default and restores full government operations. Senate Majority Leader Harry Reid, who started talks with Minority Leader Mitch McConnell, said the two had “a productive conversation” yesterday. Democrats have warned that a lack of movement this weekend may have an effect on financial markets.

“We ended the week on a pretty upbeat note with relatively high expectations that a deal to end the government shutdown was pretty near,” Oliver Pursche, who helps manage $850 million as president of Gary Goldberg Financial Services in Suffern, New York, said by phone on Oct. 13. “By yesterday afternoon, it was pretty clear that there was still a lot of work to do. That’s a disappointment and you’re seeing that natural reaction from the market.”

Short Sales

The S&P 500 climbed 2.9 percent on Oct. 10 and 11 to 1,703.20, fewer than 25 points from its record on Sept. 18. Companies with the most short sales rose 3.5 percent in the two days and erased all losses since the U.S. government shutdown began Oct. 1, data from Bloomberg and Goldman Sachs show.

The ISI index of hedge fund long versus short bets fell to 48.4 in the week ending Oct. 9, from a 2013 high of 52.5 in March, data from the New York-based research firm show. Its lowest point this year was 48.2 in August. As ISI’s index decreases, it indicates managers are growing more bearish on equities. The measure dropped 4 percent in the last three weeks.