by Chris Johnson | August 1, 2012 7:00 am
The market was stingy when it came to providing trading opportunities in July. The European debt crisis and a lackluster earnings season made bullish trade opportunities even harder to find than they were in June, with investors seemingly pulling back on the reins as the light-volume summer months continue.
While many of the indicators we watch have slowed in activity, one continues to provide ample fodder for bullish trades: the bi-weekly short interest data. The second July release of short interest data saw some significant changes as the shorting crowd is increasing their bets that the market will run into a more difficult trading environment as we head into August.
As of last week, the market was able to surge back toward the highs of the summer on news that the Fed appeared to be ready to pull the trigger on another round of quantitative easing. If this trend continues, the increase in short selling will serve as a perfect example of the “Wall of Worry” that stocks will likely climb in August as the shorts get squeezed out of their positions.
While it’s good to know that the market appears to be climbing that wall, it’s better to identify the companies that are set to potentially benefit from a short squeeze rally. Our latest pass through the short interest data has identified a “top 20” list of companies that are strong short squeeze candidates.
Our models identify a company as a short squeeze candidate when its shares are trading in a strong technical pattern while also seeing an increase in short interest. The idea is that the technical strength will force the short sellers to rush back into the market as buyers to cover their losing positions.
As simple as it sounds, this filter is extremely consistent in providing bullish trading opportunities in all market conditions.
With that in mind, let’s look at the table below and a few stocks that are strong candidates for a short cover rally. Of notable interest are the growing number of large-cap names like Altria (NYSE:MO), Heinz (NYSE:HNZ), Kimberly Clark (NYSE:KMB) and Consolidated Edison (NYSE:ED). These companies as well as Hasbro (NYSE:HAS) are becoming a larger portion of professional money managers’ portfolios given their attractive dividend yields. This helps their technical support because dividend yields remain a driving force in stock selection, thanks to rock-bottom interest rates in fixed-income markets.
Let’s take a look at a few standouts…
Leggett & Platt (NYSE: LEG): This consumer-goods company is benefiting from the renewed strength in the housing markets. Companies like Lumber Liquidators (NYSE:LL), Home Depot (NYSE:HD) and the homebuilders themselves have seen relative strength against the market as we’re starting to see interest in the housing markets begin to grow.
In addition to the rising short interest on LEG, the company’s analyst rankings remain low, with only 50% of the analysts covering the stock ranking it a buy. Over the last month, LEG shares are up 8.7% versus the S&P 500’s 1.7%. At this rate, the shorts and analysts will have to warm to the stock, helping to push it even higher.
Altria: This market outperformer is up 22% year-to-date versus the S&P 500’s return of 10%, making a short position in the stock a tough one to hold for too long. From our perspective, MO shares are set to continue their outperformance as the Wall of Worry is clearly in play. The current short interest ratio of 6.5 is the stock’s highest in more than two years, signaling the best opportunity for a short covering rally over that time.
Analyst recommendations on MO reveal only 47% buys, indicating that the analyst community has been slow to upgrade the market outperformer. As an extra bonus, Altria is one of the companies that fall into an elite group of large caps that derive 100% of their revenue from the U.S. Given the uncertainty in the international markets, we have been favoring companies that have revenue focused in the U.S.
We see MO trading to the $40 level before the summer’s close. By the way, the 4.5% dividend yield also makes this a fan favorite, which won’t hurt the stock.
Kimberly Clark: Finally, like Altria, KMB is a dividend-yielding stock that now looks ready to jump higher based on a surge in short interest. In the last month, the short interest ratio jumped nearly three-fold as short sellers appear to be stumbling over themselves to bet against the stock. The shares have outperformed the S&P 500 by a two-to-one ratio, returning 20% year-to-date.
The way the crowd is most often wrong at the end of a trend, and the fact that short sellers are betting heavily against this stock rather than for it suggests that the trend is far from over. Target a price of $95 before Labor Day.
While these three are favorites right now, the entire list of Top 20 Short Squeeze Candidates below holds a treasure trove of opportunities for short-term traders. Enjoy!
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