Short-sellers may be on to something in the UK (but they are getting stomped in the US)

“Not everyone approves of the practice of short-selling but supporters will point to the diligent research involved, the risk posed by the unlimited downside of a short position and the liquidity provided,” says Russ Mould, AJ Bell Investment Director. “Some investors may view hedge funds’ occasionally public promotion of their bearish views as distasteful, short-sellers will counter that such tactics are no different from company’s share buyback scheme or carefully-crafted (adjusted) results statement, designed to emphasise a firm’s virtues and perhaps to suggest management believes the stock is undervalued.

“Making money by going short is not as easy as it seems. Since the UK stock market hit its latest low on 27 December, just six of the 30 most-shorted shares have fallen in value. The FTSE indices have rallied, buoyed by hopes for the Sino-US trade talks, an end to the US Government shutdown and particularly softer talk the world over from central banks.

Source: www.shortracker.co.uk, Refinitiv data

“The US Federal Reserve, Bank of England, Bank of Japan, European Central Bank and the Reserve Banks of India, New Zealand and Australia have all either stepped back from talk of interest rate hikes, hinted at pauses or even rate cuts, with the new Indian governor, Shaktikanta Das, even sanctioning a rate cut, while the Fed and ECB have already discussed scenarios whereby they could return to Quantitative Easing (QE).

“Such a policy about turn is the stuff of nightmares for short-sellers as the tide of easy central bank money again starts to lift all boats.

“Bears will therefore take some comfort from their six palpable hits, which include Metro Bank and Plus500, both holed by profit warnings. They will also note with some satisfaction how their top-30 aggregate targets have fallen by 1.7% on average over the past month, while the FTSE All-Share has gained 3.6%.

Source: www.shortracker.co.uk, Refinitiv data

“Investors in these stocks must therefore try to overcome any confirmation bias, and only look for news that confirms their investment thesis on these names, and assess what the short-sellers may have seen that they have not. It could be an issue with the balance sheet, group accounting policies, strategy or simply a view that the valuation is too lofty and leaves management little or no room for error when it comes to profits, cash flow and dividends. All are worth investigating, just in case.

“Short-sellers of UK stocks are at least having more joy than bears in the USA. The S&P 500 has rallied much more strongly than the FTSE All-Share since its 24 December low and short-sellers have been hammered: the 30 most-shorted stocks are up by more than a third on average since the pre-Christmas bottom, more than twice the gain in the benchmark index.

Source: FactSet Research, WSJ Market Data, Refinitiv data

“Whether this is indicative of a healthy stock market rally remains to be seen. 

“Some of the gains are huge and suggestive of a vicious short squeeze, as shorts buy back their positions to close out and lock in remaining profits or limit losses. That creates more buying, forcing prices higher and fuelling a rally and when the most-shorted stocks outperform the wider benchmark by quite so much you do have to wonder how much of the S&P’s post-Christmas gains are the result of a short squeeze rather than genuine investor enthusiasm.

“That will be of little succour to bruised bears who are finding the going tough in the USA as the equity bull market in the US moves toward its tenth birthday next month.”

Source: FactSet Research, WSJ Market Data, Refinitiv data