Short sellers have significantly increased their bets against publicly traded Canadian companies in 2019. Is this a warning that the stock market is headed for a major downturn? What companies are targeted by short sellers and are they at risk of selling off?
The extent of short sellers’ bearishness at the macro level can be proxied by the short position in the iShares S&P/TSX 60 Index exchange-traded fund (XIU), which tracks the 60 largest and most liquid companies on the Toronto Stock Exchange. As can be seen in the accompanying chart (based on data from S3 Partners), the proportion of XIU’s float sold short has jumped to 20.9 per cent this year from 12. 3 per cent. Such a steep upward move is not often seen in XIU.
The surge in short interest occurred while XIU’s share price was in an uptrend, on its way to a 14-per-cent appreciation by mid-August. Fighting an uptrend to this extent suggests a fairly high level of conviction on the part of short sellers, who of course are betting on prices declining.
A divergence in views between the market and short sellers can be a sign of an impending inflection point, when the S&P/TSX Composite Index either falls or short sellers capitulate. If the latter occurs, it may trigger a round of short squeezes (share prices are bid upward as short sellers buy shares to return the ones they borrowed and sold).
If and when the inflection point comes, the more heavily shorted companies should be at the forefront of the action. Large short bets portend price weakness – but they can also be more easily tipped into a short squeeze.
The accompanying table lists the 10 Canadian-based companies with the highest percentage of shares short. Like last month, it is well populated with members of the cannabis and housing sectors.
Table for 0823 rb im shortsCarrie
The cost to borrow shares, shown as an annual interest rate, is included on the table as another gauge of short-seller bearishness. Notably, the high borrowing fees for most of the cannabis stocks show there is still strong demand to short their shares – which lends more support to the bearish signal implicit in a high percentage of shares sold short.
Insider trades within the past year can also assist with the interpretation of short sales. Nearly all the companies in the table had net insider selling greater than $1-million, according to INK Research. So, their short positions may indeed be signalling poor stock performance.
Mortgage insurer Genworth MI Canada Inc. was one of the most bearish. It has had net insider sales over the past 12 months of more than $6-million, most originating from senior executives – particularly the chief financial officer, who recently unloaded some holdings after the shares spiked on quarterly results released July 30.
A notable exception was alternative mortgage lender Home Capital Group Inc. It drew net insider buying of $718,147 over the year, mostly from the chief executive and chief financial officer, including a recent purchase by the latter on an uptrend in the stock price. Overall, their buying hints that the short position could be foreshadowing a short squeeze more than a price tumble.