This Well-Known Stock Could be in Trouble...

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Every two weeks, investors have a chance to parse the level of short interest among all stocks on the major exchanges. It's helpful to glance at these lists, which can be found on The Wall Street Journal's website, Nasdaq.com and elsewhere to see which companies are increasingly in the targets of short sellers. Depending on what you find, you may decide you want to jump on a heavily-shorted stock -- and ride it back up -- or sell a stock you already own that's just facing too many headwinds (even better: you could use this list to be informed enough in advance to avoid a stock).

While perusing this list, I noticed a household name is quickly moving up the leader board of short sellers: General Electic (NYSE: GE ) . Short sellers have boosted their negative bet on GE from 64.6 millionshares at the end of July to 102.6 million in the middle of August. This is a 59% jump in just two weeks, and comes after the stock market suffered through a brutal three week stretch. Clearly, short sellers think GE hasn't even begun to feel the brunt of a tougher economic climate.

Sell-side sleepers
To better understand why so many investors are starting to bet against GE, I read through a dozen analyst reports from various Wall Street firms. Strangely, they appear uniformly bullish , seemingly asleep at the wheel in acknowledging what the short sellers may be thinking about. To see what the shorts are seeing, I reached out to old colleagues that focus on short-selling to see what they are thinking and hearing about this blue-chip stock . Here are four reasons they were able to put together...

1. It's theeconomy stupid
To be sure, with $150 billion in trailing 12-month sales, and tentacles in a wide range of industries and regions, GE is a proxy for a multitude of economic trends. So some short-sellers simply see GE as a way to bet against the market and the economy in general. Yet that argument isn't quite sufficient because the short interest in GE is rising much faster than any other stock in the S&P 500.

2. Nuclear and aviation -- two challenged industries.
GE has considerable exposure to the nuclear power industry, and as countries like Germany and Japan quickly sour on this energy source, GE's power plant division starts to feel the brunt. Countries like Japan aren't looking to build more fossil fuel plants to offset expected shutdowns of nuclear plants. Instead, they are calling on its companies and citizens to simply consume less energy.

GE is also a major player in aircraft engines, and that may not be a very good place to be in coming years. Here in the United States, major carriers such as Delta Airlines (NYSE: DAL ) are starting to shrink their capacity (putting used planes onto the re-sale market) and lowering long-term plans for orders of new planes. Right now, Boeing (NYSE: BA ) and Airbus are working through an ample backlog of new orders that were placed a year or two ago, but could suddenly find a sharply-reduced backlog in 12-18 months if more carriers decide to cancel those orders.

3. GE Capital is akin to a bank stock
GE saw its shares plunge in the 2008 economic crisis because management had built up a balance sheet with far too much debt. When the financial markets temporarily seized up and GE warned it was facing a liquidity squeeze, panic set in.

These days, GE has stepped back from the precipice, leaving its balance sheet much less exposed to the overnight borrowings. But these are tough times for any lender these days -- interest rates are quite low both in the United States and Europe, dampening potential profit spreads. The prospect of a bleak year in 2012 for both the United States and Europe means GE Capital will continue to generate subpar margins -- weaker than many sell-side analysts are currently projecting, according to some short sellers.

4. Too much debt

At the height of the financial crisis, GE carried a scary amount of long-term debt -- $524 billion to be precise. This figure stands at $434 billion today, which is manageable in the context of a slow-growing economy or a mild global recession , but a potentially disastrous amount of debt if the economy hits a rougher patch than many economists currently expect. The short-term portion of GE's long-term debt has risen from $118 billion to $153 billion in just the last six months, in a possible sign of management complacency.

Will GE have to raise more capital to shore up its balance sheet? If so, then this would be a lousy time to do so, in terms of potential dilution . Any capital raise is like manna from heaven from short-sellers, because the mere announcement of such a move tends to push a stock down.

Risks to consider: Short sellers appear to be targeting a major slowdown in the global economy, and they're correct that this highly-leveragedbusiness model would suffer in such an environment. But it may be too soon to anticipate such gloom and doom. A return to the crisis-like environment of 2008/2009 seems unlikely at this point, largely because major financial institutions have shored up their capital bases since then.

Action to Take -->
Why are short sellers so bearish while Wall Street analysts (the " sell side ") appear largely bullish? It may be due to the fact that GE provides a large amount of business to Wall Street firms, which are loathe to alienate such a key customer.

The next two to three quarters will be crucial. If the European debt crisis -- or any other exogenous shock -- roils the global economic outlook, then short sellers are likely to profit from their trade. Shares could also suffer from downward earnings revisions, which have thus far been largely maintained through this summer of discontent. Analysts expect GE to boost sales at a very slow 2% next year, but those forecasts could turn negative if the U.S. and European economies recede.

Even if you're ill-inclined to short GE, this may be a bad time to go long on the stock because the economic footing remains so uncertain.


-- David Sterman

The 10 Best Stocks to Hold Forever
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Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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This article appears in: Investing , Basics

Referenced Stocks: GE

David Sterman

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