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Short Sellers Provide Great Contrarian Trades

Summer doldrums don't mean there's no squeeze candidates


The recently released short interest data is showing that the ongoing rally in stocks has likely been aided by short sellers being forced to close their bets against the market. Two-thirds of the widely traded sectors and ETFs that we track saw a decline in total short interest, indicating that the market’s continued strong performance has taken its toll on the shorts.

Among the groups that have seen more dramatic short covering are the homebuilders, health care, utility and pharmaceutical stocks, all of which have hit relative highs as of late. Conversely, the mining, oil and gas exploration, energy and semiconductor groups saw some decent increases in short interest with the last report, signaling that these stocks may have a “wall of worry” to climb.

In general, the light volume trading environment has squelched a lot of the shorting activity as the hardcore traders are likely to be spending the last of the dwindling summer days in the Hamptons or other locales away from their work desks. But that doesn’t mean there aren’t any short squeeze candidates standing out as opportunities for trades.

The table below identifies companies that have seen increases in short interest, despite the fact that they remain in strong technical uptrends. The idea of searching for technically strong companies that are attracting growing short interest is that a continuation in the technical performance will force a short squeeze rally, pushing share prices even higher.

As always, we like to highlight a few of our favorites from the list…

KB Home (NYSE:KBH): It’s always fun to watch a stock climb that wall of worry, and that’s exactly what KBH is doing right now. It’s up more than 55% year-to-date with the homebuilding market finally experiencing some strength. Fundamentally, this is finding its way to the bottom line for KBH as it beat analyst expectations for earnings this week.

Despite these positive signs, the company was recently downgraded by a large Wall Street firm, and the short sellers are adding to their positions. The classic contrarian play involves seeing increasing signs of pessimism that run counterintuitive to what the charts are saying, and that’s just how KBH is presenting right now.

We like the contrarian setup as a driver to push KBH shares toward the $13 level over the next few months. That’s a 20% move for those of you keeping score at home. It’s fun being on the right side of the contrarian trade!

ETF investors also have a few candidates on the list. First, the S&P Oil & Gas Exploration & Production ETF (NYSE:XOP). After taking a hiatus, the oil and gas trade has come back to life as global demand may not be as poor as analysts suspected earlier this year. This means oil and gas exploration companies will be ramping up production again. The shorts have been increasing their bets against this trend, just as the XOP shares are forming a strong uptrend.

As they say, “the trend is your friend,” unless you’re betting against it. With a short interest ratio of more than 9, the XOP shares are a great candidate for a short covering rally that will help push share prices toward the $58 level over the intermediate term.

Another ETF that is presenting itself as a nice bullish contrarian investment is the Select Sector Consumer Staples SPDR (NYSE:XLP). Let’s face it, investors are still anxious about the outlook for stocks through the remainder of 2012, meaning the defensive plays like consumer staples remain attractive.

The shorts don’t see it that way, though, as they continue to place bearish bets against the XLP shares, which has one of the strongest technical trends of all the widely traded ETFs. Oh yeah, the XLP boasts a 2.6% dividend yield, making it even more attractive as a well-rounded holding in most investors’ portfolios. We’re targeting a price of $40 before year-end on this defensive performer.

As of this writing Chris Johnson doesn’t hold any securities mentioned here.

Article printed from InvestorPlace Media,

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