Some Stocks We Love To Hate

Out-of-favour stocks always get my attention when they print a new 52-week high. 

I recall that on mid-day August 5,2014 the shares of New York listed United States Steel Corp.(X) were trading at a new 52-week high of just over $35. Not bad for a stock that for the most part, according to Thomson/First Call, is not overly loved by the several analysts covering the company.

More notable was U.S. Steel’s strong performance relative to the Dow Industrials as measured by their recoveries from their respective early February 2014 lows. According to S&P Dow Jones Indices as of August 5, 2014, the Dow Industrial Average was up 6.87% from its 2014 closing low of 15372.80 on Monday, February 03, 2014. Over the same period US Steel was up 39%.

After spending 100 years as a Dow Jones Industrial Average component, the old smoke-stack related U.S. Steel was removed back in May 1991 to make room for the relatively clean consumer related Walt Disney Company.

To later add insult to injury U.S. Steel was removed from the S&P500 on July 2, 2014, due to declining market capitalization. The company had been an original member of the S&P 500 since 1957.

Around the time of those February 2014 lows on the Dow and U.S. Steel, Zacks Equity Research published a research item – “Is A Short Squeeze Ahead for US Steel (X)?”

Zacks wrote, “Many investors appear to be quite bearish on United States Steel Corporation (X), especially if you look at the percentage of the float that is sold short for this stock. Currently, 22.6% of the float is sold short, suggesting an extreme level of bearishness for X.” The report went on to say the earnings estimates have actually been moving higher for the company, despite the pessimism, and as a result they were looking for shares of X to move higher in the weeks ahead.

At the time of the report the shares were in the $24 range and so the Zacks’ call for a short squeeze advance on U.S. Steel turned out to be correct – in spite of the current pessimism.

Our weekly chart of U.S. Steel vs. the Dow Industrials spans about 125 weeks and we see the poor relative performance vs. the Dow (lower plot) through 2012 to the lows of mid 2013.

In mid September 2013 U.S. Steel broke up above a declining 40-week moving average and ran up about 50% in 20 weeks to a peak in January 2014 The subsequent correction down to the February 2014 lows found support at a now rising 40-week moving average.

I have noted the period of the Zacks short squeeze report and you can see the recent price advance which is supported by the lower relative perform lines.

Just to review the definition of a Short Squeeze. According to Investopedia, a “Short Squeeze” is a situation in which a heavily shorted stock or commodity moves sharply higher, forcing more short sellers to close out their short positions and adding to the upward pressure on the stock – etc.

In other words a short squeeze is a situation in which a heavily shorted stock or commodity moves sharply higher, forcing more short sellers to close out their short positions and adding to the upward pressure on the stock or commodity.

It is important to understand that short sellers tend to be more sophisticated than long-only investors because the short seller can take on the higher risk of unlimited losses if the stock or commodity moves sharply higher.

However – while it would be prudent to respect the actions of the short sellers, we also need to see if there is a contrarian opportunity, just in case the short sellers are wrong and we have the opportunity to capitalize on a classic short squeeze.

What Investopedia doesn’t tell you is that we need three conditions that could have the shorts change their minds and decide to cover – or buy back in. We need the stock to be out-of-favour, we need the stock to be among the top 20 listed short positions and there should be recent strong performance relative to a related sector or relevant index.

A Google search on “TSX short positions” led me to several web sites to include the TSX/TSXV Market Data page which posted the top 10 TSX short positions as of July 31, 2014. The top two largest shorted names were Lundin Mining Corp. (LUN) and Bombardier Inc. (BBD.B).

The list of stocks with the greatest short sale decrease over the past 2-week period may suggest the short sellers are changing their minds and are backing away from their bearish bets on the group. At July 31, 2014 - the top two names from a group of 20 stocks with the greatest short sale decrease over the past 2-week period were the TSX listed Barrick Gold Corp. (ABX) and BombardierInc. (BBD.B)

Both of these names (like U.S. Steel) are not exactly favourite investments among investors and industry experts. Barrick Gold according to Thomson/First Call, is also not overly loved by the many analysts covering the company, with 15 holds and only 3 buy recommendations, and Bombardier gets negative reviews in both the business press and business television with most “experts” referring to the stock as a “hold” or an “avoid”.

Once again we need three conditions that could have the shorts change their minds and decide to cover – or buy back in. We need – lots of shorts, strong relative performance vs. a relevant index, and finally the stock must be out-of-favour.

Our second chart is Barrick Gold - daily - plotted above the broader TSX60 index – and as we can see by the lower relative perform lines, last June the relative perform want positive vs. the TSX60 Index. Note also the price break above the 50-day moving average. Clearly Barrick satisfies our three conditions for a potential short squeeze.

Observations:

Back on July 15, 2014 I looked at the top 20 stocks with the greatest short sale increase over the past 2-week period. There were 5 energy stocks, 5 financial stocks and 6 material stocks – the rest were industrial, health care and telecom.

It appears that materials are the most popular short sale sector led by materials component - the unpopular Teck Resources Ltd (TCK.B).

Just to review - while It would be prudent to respect the actions of the short sellers, we also need to see if there is a contrarian opportunity, just in case the short sellers are wrong and with Tech Resources trading firmly above both the 50 ad 200-day moving averages – I think they are wrong.

Bill Carrigan, CIM is an independent stock-market analyst.

He can be reached at: info@gettingtechnical.com.