Let Short Interest Be Your (General) Guide

It can be effective in finding opportunity ... if used correctly

   

The conventional wisdom holds that heavily shorted stocks have better-than-average upside, but the results of the past year show that this might only be true when the broader market is rising.

The basis for this assertion is the performance of the market’s most heavily shorted stocks in two recent periods.

The first interval was the sharp downturn that occurred from July 22-Aug. 18, 2011, during which time the SPDR S&P 500 ETF (NYSE:SPY) fell 14.91% in the span of just 19 sessions. Using data from Bespoke Investment Group, the 29 most heavily shorted stocks at that time (as of the most recent short interest report) fell 23.23%, lagging the broader market by more than 8 percentage points. All 29 stocks lost ground in that interval, and 26 performed worse than the SPY ETF. (SIPF is short interest as a percent of the float):

Stock Ticker July 2011 SIPF 7/22-8/18 return Stock Ticker July 2011 SIPF 7/22-8/18 return
First Solar FSLR 35.5% -25.65% Monster Worldwide MWW 13.3% -44.23%
AutoNation AN 32.1% -12.13% RR Donnelly RRD 12.9% -28.05%
Sears SHLD 29.7% -27.42% Tesoro TSO 12.4% -20.43%
GameStop GME 24.6% -8.70 Washington Post WPO 12.1% -21.20%
J.C. Penney JCP 21.0% -24.22% Chipotle CMG 11.5% -15.21%
Netflix NFLX 19.5% -21.37% Cerner CERN 11.2% -14.87%
SuperValu SVU 19.4% -20.71% Teradyne TER 11.2% -24.85%
Lennar LEN 17.8% -28.51% Novellus Systems NVLS 11.0% -19.85%
AK Steel AKS 17.3% -50.13% Allegheny Technologies ATI 10.8% -33.40%
Federated Investors FII 16.0% -24.37% Safeway SWY 10.8% -16.42%
Diamond Offshore DO 15.9% -15.87% Expedia EXPE 10.5% -9.99%
Vulcan Materials VMC 15.5% -16.40% Moody’s MCO 10.0% -24.52%
Urban Outfitters URBN 15.2% -20.09%
Molex MOLX 14.7% -22.00%
Advanced Micro AMD 14.4% -25.29%
US Steel X 14.4% -39.02% Average -23.23%
Best Buy BBY 13.4% -18.76% S&P 500 ETF SPY -14.91%

In contrast, heavily shorted stocks outperformed during the rally phase that occurred from Oct. 3, 2011-March 31, 2012 — though not by a large extent. During that interval, SPY gained 29.47%, while the 36 most heavily shorted stocks rose 31.31%. The dispersion of returns was much higher on the upside: 16 of the 36 stocks lagged SPY, and seven finished with negative returns:

Stock Ticker Sep 2011 SIPF 10/11/11 – 3/31/12 Return Stock Ticker Sep 2011 SIPF 10/11/11 – 3/31/12 Return
AutoNation AN 32.9% 8.78% Best Buy BBY 11.9% 7.79%
First Solar FSLR 31.7% -56.74% Microchip Technologies MCHP 11.8% 24.62%
Sears SHLD 31.2% 15.72% Expedia EXPE 11.5% -5.94%
J.C. Penney JCP 29.0% 37.40% Molex MOLX 11.4% 49.57%
GameStop GME 27.4% -4.29% Tesoro TSO 11.3% 47.39%
SuperValu SVU 23.6% -8.49% Cerner CERN 11.3% 16.17%
AK Steel AKS 23.4% 32.63% Titanium Metals TIE 11.2% -3.14%
Lennar LEN 20.8% 114.35% Whirlpool WHR 10.9% 61.06%
Vulcan Materials VMC 19.0% 63.22% MEMC Electronic Materials WFR 10.7% -24.00%
Netflix NFLX 18.7% 1.58% Fastenal FAST 10.7% 69.12%
US Steel X 18.3% 45.97% Ecolab ECL 10.5% 29.31%
Diamond Offshore DO 17.0% 29.59% Teradyne TER 10.4% 60.09%
Urban Outfitters URBN 16.2% 33.92% Chipotle CMG 10.4% 42.81%
Advanced Micro Devices AMD 16.1% 77.04% Moody’s MCO 10.3% 46.69%
Express Scripts ESRX 14.1% 51.72% Avalon Bay Communities AVB 10.2% 26.36%
Federated Investors FII 13.3% 37.91% RR Donnelly RRD 10.2% -3.12%
Pitney Bowes PBI 13.2% 0.17%
Gannett GCI 12.6% 70.71%
Harris Corp HRS 12.5% 37.69% Average 31.31%
Novellus Systems NVLS 12.1% 90.35% S&P 500 ETF SPY 29.47%

This is a small sample of data in terms of both time and the investment universe, which is limited to the S&P 500 Index. Still, the result — that high short interest is a better indicator of underperformance in down markets than it is outperformance in rising markets — is consistent with the result that one would expect from a commonsense standpoint.

Heavily shorted stocks are, by nature, going to be in the “lower quality” segment of the market, which means that investors will abandon them in times of trouble while shorts will press their bets. At the same time, a rising market will lead to short-covering that benefits some names, while others — such as First Solar (NASDAQ:FSLR) or SuperValu (NYSE:SVU) — will suffer from the deteriorating fundamentals that attracted short-sellers in the first place.

The conclusion: High short interest might indicate an opportunity, but the most important aspect of the trade is being correct in the direction of the broader market.

According to the website highshortinterest.com, the most heavily shorted stocks (by percentage of float) in the U.S. market are: Skullcandy (NASDAQ:SKUL), Teavana Holdings (NYSE:TEA), Groupon (NASDAQ:GRPN), hhgregg (NYSE:HGG), Sodasteam International (NASDAQ:SODA), Vera Bradley (NASDAQ:VRA) and Diamond Foods (NASDAQ:DMND).

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2012/04/let-short-interest-be-your-general-guide/.

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