An old Chinese proverb says that flies usually hover over rotten eggs. The same could apply to investing.
More often than not, the next stock market dud attracts the attention of short sellers long before fundamentals start to deteriorate. These sophisticated investors sell shares they don’t own hoping to profit when a stock falls.
A number of academic studies show that an increase in short activity is a big red flag. But how can you follow these money mavens?
Fortunately, the TMX Group publishes its Top 20 Largest Consolidated Short Position Report twice a month. It’s like a window into the minds of these traders. The table below summarizes the biggest increases of short activity in the latest report.
| Company Name | Feb 15 | Jan 31 | Net Increase |
|---|---|---|---|
| New Gold Inc. | 33,968,090 | 31,140,066 | 2,828,024 |
| Crescent Point Energy Corp. | 14,786,224 | 12,031,999 | 2,754,225 |
| Enerplus Corp. | 7,460,262 | 5,088,104 | 2,372,158 |
| Potash Corp. | 23,777,191 | 22,016,868 | 1,760,323 |
| Bank Of Montreal | 13,383,782 | 11,972,152 | 1,411,630 |
Source: TMX
What happens when you combine expensive shale plays and lower energy prices? Big losses. The doldrums in the oil patch have crushed energy stocks. But drillers focused on high-cost shale plays like Enerplus Corp. (TSX:ERF)(NYSE:ERF) and Crescent Point Energy Corp. (TSX:CPG)(NYSE:CPG) have been hammered worst of all.
That said, the industry is taking the tough medicine needed to weather the storm — i.e., layoffs, spending cuts, etc. But what these companies really need is a big rally in oil prices. Short sellers don’t see a turnaround anytime soon.
Weak oil prices are also rippling through the financial industry. Short sellers are betting against the Bank of Montreal (TSX:BMO)(NYSE:BMO) on worries that falling energy prices could result in higher loan defaults. Even worse, investors fear that low oil prices could prick the bubbly Canadian housing market. Needless to say, that would result in big losses for lenders like Bank of Montreal.
Gold miners are also under pressure in the face of low metal prices. Companies are being forced to cut costs, slash dividends, and shutter mines with less cash coming in the door. Many are resorting to diluting shareholders with equity issues just to keep the lights on. Junior and mid-tier miners like New Gold Inc (TSX:NGD)(NYSE:NGD) are particularly exposed.
Of course, before you panic and bail on any of these stocks, it’s important to note that these positions might not represent outright bets against a company. Short sales may only be one leg of a bigger trade.
That said, a big change in short activity is a red flag. Investors should take note.
