Now Showing, Again: 'Get Shorty'
Year-End Tactic Involves Buying Shorted Stocks, Squeezing Holders, Thus Spurring Even More Gains
By GREGORY ZUCKERMAN
Staff Reporter of THE WALL STREET JOURNAL
November 17, 2005; Page C1
IT MAY BE TIME for another installment of "Get Shorty" on Wall Street.
As the market enters the year's final weeks, some traders are focused on a short-term strategy: snapping up shares of companies that are big targets of short-sellers.
At first glance, the strategy may not make such sense. Short sellers bet against stocks by borrowing shares and selling them. Their hope is that the stocks drop, and they can make money by buying the shares back and returning them at a lower price.
The strategy has worked in recent years, with many of these heavily shorted stocks soaring in November and December. Why? Because other investors -- sometimes mutual funds, sometimes other hedge funds -- have embraced a strategy that some slyly refer to as "Get Shorty," based on the 1995 John Travolta movie. As part of the tactic, traders pile into these despised stocks, moving them higher. The movement can force nervous short sellers to "cover" their positions by buying them back, sending the stocks higher still in a so-called short squeeze.
Others focus on stocks that are heavily shorted, hoping that a glimmer of good news pushes the stocks higher, as short-sellers buy back shares to avoid losses. The best targets: Stocks with high short interest that have climbed this year, saddling the shorts with losses and putting them close to throwing in the towel.
The calendar drives much of this. Hedge funds -- shorts and longs -- are paid based on their performance for the year. That means these big investors get nervous as Dec. 31 nears, and sometimes jittery shorts will scramble to cover their positions, making a short squeeze more likely than it would be earlier in the year, though some of it also happens at the end of each quarter. Mutual funds and hedge funds on the opposite side of the trade also usually get paid for their year-end performance, increasing their incentive to pick on the shorts. At the same time, if a "Get Shorty" strategy isn't working, longs may get antsy and bail out of a position, giving shorts a victory. It is a Wall Street version of playing chicken, with the shorts usually swerving first.
Over the past four years, the five most heavily shorted companies in the Standard & Poor's 500-stock Index scored gains that were 14.8 percentage points above those of other stocks in the S&P 500 during the last two months of the year, according TFS Capital LLC, a West Chester, Pa., firm that manages the TFS Market Neutral mutual fund, as well as several hedge funds. TFS, like others, evaluates short interest by comparing shares sold short to both shares outstanding and average trading volume. Last year, the five most heavily shorted stocks based in TFS's measure outperformed the S&P 500 by 7.2 percentage points in the period.
The pattern also is true of smaller stocks. The five most heavily shorted small-cap stocks outperformed other small stocks by 13.7 percentage points during the last two months of the year during the last four years. Last year, the five most heavily shorted small stocks rose 28% in the last two months, compared with a rise of just 11.6% for other small stocks in that period.
"I believe that big holders of stocks examine the short-interest tables, and understand that if these stocks trade up a short squeeze will take place," says Seth Tobias, general partner of New York hedge fund Circle T Partners, who sometimes looks to buy heavily shorted stocks.
Of course, the data from the last four years may be an aberration. And the most heavily shorted stocks have done worse than the overall market during the first two weeks of November this year. One reason betting on heavily shorted stocks at year's end may be working in recent years: There are so many more hedge funds, increasing the number of traders playing the game. The problem with this strategy is the opportunity doesn't last long. Often the same heavily shorted stocks that climb in price during the year's last leg quickly come back to earth when the calendar turns.
Last year, Taser International, a stun-gun maker that at the time was the most heavily shorted stock based on shares outstanding, traded at a split-adjusted price of $20.45 at the end of October, but it soared to $31.65 by the end of 2004 before tumbling to less than $18 by the end of January of this year. As of 4 p.m. composite trading yesterday on the Nasdaq Stock Market, Taser was at $7.35, up 24 cents. Navarre, a software distributor targeted by shorts, jumped from $15 at the end of October last year to $17.60 at the end of 2004. But it fell to $12.38 at the end of January last year, and was at $3.51, off 43 cents, yesterday at 4 p.m. on Nasdaq.
While the short-term strategy has worked in recent years, a longer view shows that it generally pays to steer clear of heavily shorted stocks. An equally weighted basket of 100 stocks in the S&P 500 with the highest short interest at the beginning of the year had an average annual gain of 8% since January 2001, compared with a rise of 14% for an equally weighted basket of 100 stocks with the least amount of short interest, according to TFS. For small-cap stocks, those with the least amount of short interest also beat those with the most short interest during each year of the past decade.
"Short-sellers typically are more informed, and by taking a similar position in the stock you are riding the coattails of the work of the smart money," says Richard Gates, portfolio manager at TFS. "The year-end trend is something we are keeping an eye on but we're not convinced the trend trumps the predictive power of short interest" over the long term.
What stocks are possible targets of squeezes this year? Traders already see it happening to Hansen Natural, maker of Monster Energy drink, which has seen 36% of its shares shorted but has soared to $69.88, as of yesterday on Nasdaq, from $50.52 at the beginning of this month. Healthcare-information provider Cerner, which has seen 29% of its shares outstanding shorted, has climbed to $92.81 on Nasdaq from $84.45 in November.
Phil Erlanger Research, a service used by some traders to find heavily shorted stocks that could rise based on a variety of factors, sees Carlisle and SPX, both of which service the auto industry, as possible short-term buys. There has been so much short selling in those stocks that it would take about seven days for short sellers to buy back their Carlisle and SPX positions based on recent volume, assuming the volume stays constant.
If it takes several days for short sellers to theoretically cover a position it suggests that so many are shorting the stock that if the stock starts rising many traders could be forced to rush in and add to the buying to avoid losses. By comparison, buying back the short interest in popular companies such as General Electric and International Business Machines would take about two days, based on average daily volume. Erlanger also likes New York Times, which would require 12 days for short-sellers to cover their positions. Others expect short targets like Web firms Audible and Netflix to rise.
Write to Gregory Zuckerman at gregory.zuckerman@wsj.com1
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