We’re seeing an increase in short positions as short sellers are posturing for some end-of-year volatility, perhaps because we’ve not yet seen lawmakers strike a deal to avoid the fiscal cliff.
While we can understand the temptation to bet against a deal, there are some signs that the two sides might be inching closer to an eleventh-hour arrangement, which will put the shorts back in the familiar position of covering as the market unexpectedly rallies.
As a general rule, short interest is an incredibly effective bullish indicator when the technical and fundamental picture for the underlying stock is positive. As such, we love to take the other side of these contrarian trades.
According to the most recent data, short interest for the S&P 500 Index itself has ticked upward, indicating a higher chance of a short-covering rally driving the whole market higher — but what we really like are some of the names in the table below.
Stocks in this table are among the highest likely to see a short covering rally based on their current technical picture. Each of these stocks are trading above their 50-day moving average — a sign of technical strength. In addition, those 50-day trendlines are moving higher, indicating that the trend is these stocks’ friend. Yet despite the positive technical picture, the shorts have been adding to their already lofty positions, as each stock saw an increase in short interest over the last two weeks.
Among the list of short squeeze candidates are two homebuilders that have attracted our attention for the last six months, Lennar (NYSE:LEN) and Leggett & Platt (NYSE:LEG). Riding the strong trend that the homebuilders have set in place, these two companies are among the better-performing names in the group. To date, Lennar shares are up more than 90% against the S&P 500 return of 14%, but that hasn’t deterred the short sellers that now have more than six times the average daily volume for the stock as short positions.
Click to Enlarge Contrarian setups work best when they are counter to the technical and fundamental picture, and this fits the bill. With strong housing numbers continuing to flow across the tape, names like Lennar will continue to rally, forcing the shorts to push prices even higher as they close their losing positions.
Click to Enlarge Similarly, Leggett & Platt has rallied, though not to the same degree as LEN.
LEG shares are up almost 20% year-to-date, and recently posted a successful test of their 50-day moving average, which should get the shorts nervous. We’re expecting the short covering to commence soon, as the shares were crossing above their 20-day trendline Tuesday.
In addition to the short cover potential, we love the fact that only 50% of the analysts covering the stock have it ranked a “buy,” as we’ll expect to see some upgrades in LEG’s future.
Discretionary spending is starting to show some signs of coming back; consumers will feel much better when the fiscal cliff is resolved. One group of stocks that will benefit from this are the travel & leisure companies like Expedia (NASDAQ:EXPE).
EXPE already has posted a good run for 2012, as the company has bested analyst earnings expectations by more than 25% over the last year.
Click to Enlarge Shares are in a strong uptrend and are threatening to break into further new high territory. What’s more, EXPE shares have been pummeling competitor Priceline (NASDAQ:PCLN) during the past year as EXPE has returned more than 100% — three times that of media darling PCLN. Nothing gets shorts running for the exit (a good thing for those holding the stock) like a company posting new highs, which means we like EXPE over the short run.
On an interesting note, the short sellers finally are taking note of the disparity between EXPE and PCLN, and the short interest ratio for PCLN is skyrocketing. Expect PCLN to gain potential for a game of catch-up with EXPE soon, as the crowd is getting more bearish on these shares.
As of this writing, Johnson Research Group did not hold a position in any of the aforementioned securities.