There's one huge risk in investing on the short side of a
heavily-shorted stock. If short sellers are forced to cover their
positions by buying back borrowed
, then they unwittingly help spur a buying frenzy, pushing a stock
up quickly. With the
steadily rebounding, that's precisely what's been happening, as the
shorts' favorite targets are some of the biggest gainers of 2012.
Paradoxically, that makes this a great time initiate a fresh short
position in these very same stocks. Short sellers already pointed
the way to problematic business models, and at higher prices than
when they were initially targeted, they could easily be even more
Short sellers are likely to retarget these names when they are done
licking their bloody paws, but you have a chance to go short in
these stocks before them.
Even if you don't tend to be a short seller, the
should at least compel you to take profits if you are hold these
stocks in a long position. They've been pushed up by exogenous
factors and are likely to fall back once the current rally peters
The stocks below have all risen at least 30% in just the first
seven weeks of 2011...
Unwarranted rising confidence in BofA
The sharp rebound in
Bank of America's (NYSE:
stock has caught short-sellers off guard. They were right in
targeting a troubled business that is still back-peddling in the
wake of past misdeeds, but the shorts fell victim to generally
improving sentiment toward banks. Analysts who follow the bank say
the rally is overdone and shares are due to pull back.
Shares of BofA have risen from $5 in mid-December to a recent $8,
but analysts at Sterne Agee say shares are worth just $6 on a
fundamental basis. Their
take stems from a "weak profitability outlook and regulatory
uncertainty given the outsized off-balance sheet liabilities."
Mexico's fortunes are rising, but don't be fooled...
Mexico-based cement maker
has staged a remarkable rebound, rising from under $3 in September
to a recent $8. Short-sellers have been fixated on the company's
, and their short-covering has helped fuel the stock's rise. To be
sure, the company's
look a bit better now than they did a few quarters ago, thanks to
sales and a modest
in demand. As a result, Cemex is no longer in breach of financial
Nevertheless, Cemex still carries $18 billion in debt and can ill
afford a renewed slump in global economic activity. (The company
has operations in Mexico, the United States and Europe). Now
trading at more than 10 times trailing
, shares seem to have overshot the mark and look ripe for a
pullback. These kinds of businesses often trade for closer to six
or seven times EBITDA. [I recently wrote about the rising fortunes
of the Mexican
in light of China's challenges, and there are some stocks worth
looking into if you want to
from this trend.
Go here to read my original take
The housing rally is overdone
I've recently been noting the strong (and likely overdone) rally in
suggesting they are ripe for a pullback
may be the ripest of all. The homebuilder, which has been a
favorite of short sellers, has risen more than 100% since the
market turned up four months ago. Last fall, trading at a steep
, shares may have seemed like a bargain. Now trading at 1.5 times
book value, they are clearly overvalued in the context of the
holdings and other assets.
A two-faced stock indeed...
The rising market has shifted the spotlight back to fund management
companies as investors start to pour money back into
. The sector's shares have been making a nice upward move, led by
Janus Capital's (NYSE:
nearly 40% gain this year. This outsized performance is likely
attributable to short-covering because Janus is one the sector's
weaker players, dogged by steady continuing outflows at several of
its top mutual funds.
Merrill Lynch sees Janus'
dropping from $0.81 per share in 2011 to just $0.54 this year,
thanks to reduced fund management fees as assets under management
continue to drop. Shares have moved up from $6 in mid-December to a
recent $8.75, but Merrill Lynch, with an "
" rating, sees shares dropping back to $7.
Solar woes will likely continue
Lastly, you'll note an
exchange-traded fund (
in the table above. The
Guggenheim Solar ETF (NYSE:
has been heavily-shorted, but shorts had to scramble to cover after
Deutsche Bank predicted last month that the solar industry has
likely hit bottom. Many investors are dubious of that view, and
even if the industry doesn't head into a deeper slump, the recent
rally more than reflects any early-stage rebounds to come.
Risks to Consider:
If the market keeps on rising, then short sellers will keep on
covering their positions, so could pay to wait for clearer signs
that the recent rally has lost steam.
Action to Take -->
This is one of the best opportunities for short-selling in a number
of months, because short sellers have unwittingly pushed these
. I like to look for a stock chart that starts to move sideways,
because that is a clear sign that
is over and the risk is lowered that further short squeezes lie
ahead. Any of the stocks I mention above are good candidates for
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-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.
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