by Daniel Putnam | April 24, 2012 1:28 pm
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%|
|AK Steel||AKS||17.3%||-50.13%||Allegheny Technologies||ATI||10.8%||-33.40%|
|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|
|First Solar||FSLR||31.7%||-56.74%||Microchip Technologies||MCHP||11.8%||24.62%|
|AK Steel||AKS||23.4%||32.63%||Titanium Metals||TIE||11.2%||-3.14%|
|Vulcan Materials||VMC||19.0%||63.22%||MEMC Electronic Materials||WFR||10.7%||-24.00%|
|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%|
|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.
Source URL: http://investorplace.com/2012/04/let-short-interest-be-your-general-guide/
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