The first set of short interest data for June recently was released and, as usual, the data is teeming with potential trade setups.
As you would expect, short interest climbed in the second half of May as traders reacted to the continued weakness in the market by adding to their existing shorts. For the two weeks, reported short interest increased by a little more than 4%, reflecting growing pessimism toward that market’s outlook. From the contrarian perspective, the growing number of short shares is a potential positive for the market, as it signals the market might be closer to capitulating.
First, let’s understand why this information is valuable to us.
Short sellers are investors, or investment professionals, that are actively betting against a stock or exchange-traded fund. By monitoring short interest, we often are able to find situations where a potential short squeeze is developing, thus providing bullish investors with excellent trade fodder.
Despite the recent weakness in the market, a number of companies are standing out as potentially bullish trades based on their potential for a short-covering rally. Every two weeks (when the short interest data is released), we filter through the data to identify potential bullish trades. Typically, we’re looking for stocks that meet the following criteria:
- A stock or ETF is trading in a strong technical fashion, typically above its 50-day moving average
- Short interest on the stock or ETF is relatively high
- The fundamental outlook for the stock is relatively positive
In a nutshell, these guidelines can be summed up by saying that we look for stocks and ETFs that investors are shorting when all other indications are telling them that they should be buyers. While not always the case, many of these situations wind up pressuring the short sellers to cover their positions when the stock or ETF continues to press higher — a.k.a., a short-squeeze rally.
The table below identifies 15 companies that have seen some relatively high short-interest activity despite recent strong technical trends. In many cases, the recent weakness in the market has taken some of these companies just below their respective 50-day moving averages, thus providing the technical crowd a good opportunity to move into these shares.
The fact these companies now are trading back above their respective 50-day moving averages and beating the market from a relative strength basis suggests that those traders who are short these stocks will begin to feel pressure to close out the trades as they move against them. That move should help to spark a round of short-squeeze pops on many of these names.
A couple of favorites on the list:
- Cincinnati Financial (NASDAQ:CINF): CINF, a property and casualty insurance company based in Cincinnati, has spent much of the past year outpacing the market, returning more than 18% since January while the S&P 500 has scraped out a small 2% gain. Short sellers continue to mount an offensive against CINF despite the shares’ outperformance. We believe the high-dividend-paying stock will continue to attract investors, forcing the shorts to cover their bad bets, driving their price higher.
- AutoNation (NYSE:AN): With the economy still standing on shaky ground, consumers continue to take the “discount” approach to making their purchases. As a result of this behavior, companies like Dollar Tree (NASDAQ:DLTR), Family Dollar (NYSE:FDO) and TJX Companies (NYSE:TJX) have performed well in the retail sector. AutoNation offers comparable options for automobile consumers as the company offers value-based new and used vehicles along with various services. The company’s stock is among the minority as it currently trades above its 50-day moving average, which is trending higher — something that can be said of only 98 companies in the S&P 500 as of today. We like the potential for a short-covering rally, as AutoNation’s technical and fundamental strength should put the short sellers on the run soon.
We’ll update this list with its notables again in a few weeks when the new short interest data is released.