What moves are short sellers currently making on Canadian stock exchanges? These moves can provide some suggestions for stocks to avoid, or even for stocks to sell short (which involves borrowing shares via a broker and selling them in hopes of buying back at a lower price).
A study published in the March 2020 issue of the Review of Finance adds to the growing body of peer-reviewed literature that finds short sellers are informed traders who tend to get it right. In What Do Short Sellers Know? Professor Ekkehart Boehmer and his co-authors report that short sellers’ ability to identify underperforming stocks has a lot to do with anticipating earnings announcements and broker recommendations.
The short position in the iShares S&P/TSX 60 exchange-traded fund (XIU-T) is a good first stop for seeing what short sellers are up to. This established and highly liquid ETF tracks the overall direction of the Toronto Stock Exchange (TSX) and has emerged as the most popular of ETFs for betting on, or hedging against, broad declines in Canadian stocks.
As can be seen in the graph, XIU is currently attracting a high level of short sales. Indeed, the short position is not only at its highest for 2020 but also relative to data for the past five years (not shown). As such, it demonstrates that concerns over a market downturn are as elevated as they have ever been since 2015.
At the company level, precious-metals stocks are seeing big jumps in short selling, according to data provided by research firm S3 Partners. Indeed, Barrick Gold Corp., Wheaton Precious Metals and Franco-Nevada Corp. top the list of the largest monthly increases in short interest as of July 20. They also have some of the largest increases over the last three months.
Some of the biggest decreases in short selling in the past month have been recorded by bank stocks, notably Bank of Nova Scotia, CIBC and TD Bank. This is consistent with the downward trend in short sales for the banking sector over the previous three months. Shopify also had a big drop this past month, following a sharp run-up during previous months.
Next, let’s take a look at companies with the largest short positions as a percentage of their freely floating shares. Alpha Pro Tech once again tops this group, with a whopping 51.7 per cent of its float sold short.
The company’s product line of protective apparel and face masks is very much in demand during the COVID-19 pandemic, resulting in its stock more than quadrupling in value over the past five months. This kind of price spike has happened to Alpha Pro Tech’s stock during past virus flare-ups, such as SARS; if the historical pattern holds the price will fall back below $5 once the current pandemic subsides.
Some stocks particularly at risk of underperforming are those targeted by activist short sellers. Aided by their campaigns to disseminate bearish views via research reports, media interviews and social media, this group of short sellers seems to be the most effective in predicting stock meltdowns (although the calls may at times take a while to unfold).
The research firm Breakout Point monitors short sellers worldwide and recently reported that eight campaigns were launched by activist short sellers against Canadian companies in the first half of 2020. Some of these companies, such as cannabis processor Pharmacielo Ltd., are already down substantially. On the other hand, shares in augmented reality firm Nextech AR Solutions have tripled in value since mid-June, albeit with extreme price volatility.
Another gauge of short-seller sentiment is the cost to borrow shares. If a company has few shares available for borrowing, short seller bearishness will be reflected more in the cost to borrow rather than the number, or dollar value, of shares short.
If the demand to go short is high when the supply of loanable shares is low, the cost to borrow can become quite elevated. Indeed, the annualized borrowing cost is currently over 100 per cent for three companies: Eastmain Resources Inc., Platinum Group Metals Ltd. and Electrovaya Inc.
Smaller investors with aggressive risk appetites might want to explore going long in a few of these typically microcap stocks, considering some brokers share the lending fees with their clients. Also, capital gains can be outsized due to short squeezes and other factors. For example, year-to-date appreciation in Electrovaya’s stock now exceeds 230 per cent.
Larry MacDonald is an author, journalist and economist. He can be reached at mccolumn@yahoo.com