In this update on the short selling of Canadian public companies, we cover: 1) bearish bets at the company and ETF levels, 2) stocks vulnerable to short squeezes, 3) the crowding out of short sellers by passive and index investors, 4) sell recommendations from independent analysts, 5) the greater hardships now facing short sellers, and 6) an endnote about data sources.
1. Bearish bets at the company and ETF levels
Academic studies have found that companies with large short positions tend to underperform the stock market on average.
At the company level, Air Canada (AC-T) again tops the list for small caps. More than 31 per cent of its float was sold short, an increase from 26.0 per cent in July. As mentioned last month, contracts with labour unions are coming up for negotiations; rivals are expanding routes.
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Next, mid-cap companies:
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Then, large caps:
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Short sales in ETFs can highlight sectors of the economy with elevated bearish sentiment.
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2. Stocks vulnerable to short squeezes
While short positions may warn of underperformance in a stock, short sellers can unintentionally push stock prices higher if they rush to buy back the shares they borrowed.
Such panic buying could be triggered by mounting losses, higher borrowing costs, dwindling trading volumes and other factors. S3 Partners combines these factors into an algorithm, called the Short Squeeze Score, to rank companies by the likelihood of a short squeeze — with 100 being the highest probability and 0 being the lowest.
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3. Passive investing is crashing the short sellers party
Carson Block, founder of short-selling firm Muddy Waters Capital, said in a recent Bloomberg Television interview:
“So much of what moves stocks is really just flows into and out of index funds. As a short seller, you have to be attuned to this and stay away from names that have significant passive ownership . . . . when you have inflows into those passive funds, they will buy the stocks at any price ... .”
In addition, Harvard University professor Philippe van der Beck and co-authors had a similar observation in their study, Ponzi Funds. They noted that when ETFs with concentrated portfolios put money inflows to work, stock holdings with large short positions may have their prices pushed significantly higher by short sellers covering their bets.
These squeezes then boost the value of the ETF, which, in turn, attracts new money inflows from performance-chasing investors, which in turn, trigger more short squeezes. The result may be a self-feeding upward spiral for the ETF.
It would not be surprising if the authors of the Ponzi Fund study had in mind the eight-fold appreciation in Cathie Wood’s ARK Innovation ETF (ARKK-A) over the five years to 2021. It held a concentrated basket of tech companies, many of which were heavily shorted — for example Tesla Motors.
4. Sell ratings from independent investment analysts
Only 6.1 per cent of stock ratings by U.S. brokerages were sell-equivalent recommendations during the past five years, according to FactSet. A firm where analysts have more freedom is Toronto-based Veritas Investment Research. In recent weeks, Veritas issued several Sell/Reduce rankings (approximately a quarter of total calls). Here is a sampling:
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5. The greater burden facing short sellers
Not only is indexing and passive investing crowding out short sellers, but the macro environment is not very supportive either. The lack of any serious recession since the bear market of 2008 means short sellers have been swimming against the tide for a long time, and long investors have become complacent about hedging.
The pickings must be slim if even the legendary Jim Chanos, a short seller for nearly a half century, has decided to close his long-running hedge fund. Its assets under management had dwindled to US$200-million in 2023, down from US$6-billion in 2008.
Moreover, lawyers at the U.S. Department of Justice and Securities Exchange Commission have recently laid charges against activist short seller Andrew Left of Citron Research and Toronto-based hedge-fund manager Anson Capital. No doubt the charges are having a chilling effect on the short-selling community at large. .
Not to be overlooked is the rise in short squeezes. The more prominent cases were those orchestrated in “meme stocks” by the Reddit gang (and, as some observers say, the hedge funds behind them).
There have also been squeezes created through swaps and other financial instruments that hide the moves of family offices (which are unregulated). One instant came to light in July when a court ruling found Archegos Capital Management guilty of market manipulation in stocks heavily sold short, notably GSX Techedu (a Chinese online education company).
Quite a few challenges face short sellers, and many of them have exited the market. In 2023, there were 14 funds in the HFR Short-Bias Hedge Fund Index, compared to 50 in 2008.
Yet, as Mr. Chanos told Bloomberg Television: “This is the golden age of fraud. There’s just so many companies now that are playing games, trying to take advantage of investors. So, we need short sellers more than ever.”
6. End note
S3 Partners was the source for short-sales data. It was selected because Canada has many companies interlisted on exchanges in the United States, and S3 Partners sums short positions (currency-adjusted) across both countries. Other data sources for short sales data don’t do this. Also note that short positions, regardless of data source, may not be purely bearish bets because of trades made for hedging/arbitrage reasons.
Larry MacDonald is a regular contributor to the Globe & Mail and author of a new book, The Shopify Story: How a Startup Rocketed to E-commerce Giant.