6 Short Cover Rallies to Avoid at All Costs

by Johnson Research Group | November 29, 2012 2:48 pm

Stock market crashUsually, I discuss using short interest data as a bullish indicator on a technically strong stock … the idea being that a highly shorted stock that’s trending higher is more likely to force the short sellers to cover their positions, sending it even higher. Typically, these short squeezes strengthen an already strong trend.

There is another scenario, though — the one where the shorts are right. Short sellers can cause a short squeeze on a stock that has been trending lower when they lock in profits. Mechanically, it works the same, as short sellers have to buy shares back to close their profitable positions. The added buying creates demand for the shares, and they will tend to outperform the market over the short run.

Note that I said the “short run.” Just because a stock gets a short squeeze doesn’t mean it’s a good buy at that time. As a matter of fact, many well-known companies that recently have seen short covering rallies but should remain out of your portfolio — the short covering pop is likely to be nothing more than a speed bump before these stocks move lower.

Here are a few to avoid:

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Green Mountain Coffee Roasters

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Tucked away in Vermont, Green Mountain Coffee Roasters (NASDAQ:GMCR[2]) brands, produces and sells approximately 200 varieties of coffee, cocoa, teas and other beverages. The company is synonymous with its Keurig single-cup coffee machines, as the K-Cup portion packs are their bread-and-butter business. This company is a favorite of the shorts as it is down 18% for the year.

Short interest on GMCR was sitting near its highs of 13 ahead of earnings this week — a dangerous proposition for a short seller. Unexpectedly, GMCR reported earnings that were better than expected earlier this week, triggering a rally in the stock that had to have shaken out the shorts.

From my perspective, the term “blind squirrel finding a nut” feels about right.

GMCR shares are more than 45% higher than before the earnings report, with the shorts likely having already moved out of their positions. We expect this to be a speed bump on an otherwise wretched stock chart; the shorts will start initiating new positions on GMCR as the shine dulls from this week’s earnings news.

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Retailer JCPenney (NYSE:JCP[3]) just grabbed headlines when Jim Cramer talked about how his sources had suggested JCP sales were going better than expected for the shopping season. The buzz shook the shorts, which had shorted JCP to its highest ratio in more than a year, at 13 times the average daily traded volume.

JCP shares are up more than 15% since the market hit its November lows, and yesterday’s news was likely to get the shorts covering their profitable positions. Our expectations are that JCP will continue to misfire through the critical holiday shopping season, meaning that now’s a good time to sell into the short-term strength and maybe even short the stock.

Either way, I don’t think it’s time to buy the stock on the recent rally.

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Rare-earth darling Molycorp (NYSE:MCP[4]) is close to a 50% return from its November lows as short sellers scrambled to cover their profitable positions.

This stock has fallen off of the cliff in 2012, declining 65% as demand for their products has dropped. Don’t expect to see the market drive prices much higher, though, as significant overhead resistance is in place at $8.82.

Don’t buy the pop here — I expect to see MCP trade back toward its lows of around $6 again.

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In a sign that the cell phone manufacturer is all but dead, Nokia (NYSE:NOK[5]) shares have screamed higher by more than 20% over the last two weeks. News that its new handset has been flying off of European shelves sparked a short covering rally, but it appears the rally might have run its course.

Technical resistance at the $3.50 mark looks to be a huge task for the shares to overcome, and any weakness is likely to push NOK back toward its trading range drawn between $2.50 and $3.

The easy money on a NOK short squeeze has been made. Take a look at other companies in the handset universe like Apple (NASDAQ:AAPL[6]) or Google (NASDAQ:GOOG[7]) — which owns Motorola Mobility and is behind the popular Android OS — if you want to trade in the sector.

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Research In Motion

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Research In Motion (NASDAQ:RIMM[8]) feels like a broken record, and the shorts have been making a killing on the song.

There have been a number of news stories on RIMM lately with the approaching release of BB10. Unfortunately, this is a trend that we’ve seen before.

Shorts were loaded up ahead of the recent media buzz, as the short interest ratio for RIMM moved back above 7 earlier this month. Shares are more than 40% higher from their prices a few weeks ago, and I’m fairly sure short covering has had a lot to do with the move.

If you’ve been holding the stock, the recent strength might be your chance to exit on some strength. If you don’t own it, hold off on buying this short squeeze, then re-read the last sentence of our Nokia commentary.

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Down 77% so far for 2012, RadioShack (NYSE:RSH[9]) shares are teasing those investors that like to buy the single-digit comeback plays, but don’t jump on the … you know, I don’t even know what to call RadioShack, which is part of its problem.

Let’s face it: The “Shack” has been trying to change its image away from the store that the techno-geeks go to for electronic parts (I think I can say that since I still shop there for solder, wires and other gadgets), but it never will compete with larger vendors like Best Buy (NYSE:BBY[10]) that we get our gadgets from, not to mention Amazon (NASDAQ:AMZN[11]).

The 15% jump in prices over the last week was likely to be the shorts closing profitable positions. They’ll likely circle around to add new shorts since there’s still meat on the bones for the vultures (short sellers) to dine on.

Don’t buy the pop here.

As of this writing, Johnson Research Group did not hold a position in any of the aforementioned securities.

  1. Compare Brokers: https://investorplace.com/options-trading/broker-center/
  2. GMCR: http://studio-5.financialcontent.com/investplace/quote?Symbol=GMCR
  3. JCP: http://studio-5.financialcontent.com/investplace/quote?Symbol=JCP
  4. MCP: http://studio-5.financialcontent.com/investplace/quote?Symbol=MCP
  5. NOK: http://studio-5.financialcontent.com/investplace/quote?Symbol=NOK
  6. AAPL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAPL
  7. GOOG: http://studio-5.financialcontent.com/investplace/quote?Symbol=GOOG
  8. RIMM: http://studio-5.financialcontent.com/investplace/quote?Symbol=RIMM
  9. RSH: http://studio-5.financialcontent.com/investplace/quote?Symbol=RSH
  10. BBY: http://studio-5.financialcontent.com/investplace/quote?Symbol=BBY
  11. AMZN: http://studio-5.financialcontent.com/investplace/quote?Symbol=AMZN

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