For over a year we have discussed that in Bernanke's centrally-planned markets, in which the risk-return formula is now wholly absent the former, the best source of "alpha" (purely in the context of recognizing that the market has become a complete and total joke) for over a year has been going long the most shorted companies. And as we reminded just over a month ago, the most shorted stocks have returned double the broader market in the past year alone. Which is why we were not surprised to see that none other than Goldman yesterday, issued research formalizing none other than going long the most shorted stocks in a piece titled "Investors focused on the results of high short interest stocks." Since Goldman is legendary for flipping at inflection points, especially with a 1+ year delay after the strategy has been working flawlessly, this probably means that going long the most shorted stocks is no longer a viable source of "alpha."
Short interest as a percent of S&P 500 market cap is currently 2.1%, in line with the average over the past year. While the share of market cap held short stayed flat, the short interest ratio (days to cover) has risen steadily since April 2012 as volumes remained low.
This week, investors focused on how stocks with high short interest as a share of market cap are trading this earnings season. Of the top 50 reported S&P 500 companies ranked by short interest, short interest ranges from 6% to 31% of market cap. Short interest for the median S&P 500 stock is 2.1% of float cap.
High short interest stocks reported a similar frequency of earnings beats and misses. Revenue results skewed more positive. 26% of S&P 500 companies beat revenue expectations while 36% of high short interest stocks exceeded consensus expectations by one standard deviation or more.
High short interest stocks were more likely to outperform the market on the next trading day than the typical S&P 500 stock indicating that there may be short covering post-earnings results. 58% of the high short interest names outperformed the S&P 500 one day after reporting results versus 47% for all reported S&P 500 companies.
However, performance of the median high short interest stock is similar to the median S&P 500 stock since the start of earnings season. Since October 4, the median high short interest stock returned 4.6% while median S&P 500 stock returned 4.1%.
Next week, six stocks with over 10% of float share held short are expected to report: Frontier Communications (FTR), IntercontinentalExchange (ICE), Windstream Holdings (WIN), Chesapeake Energy (CHK), Dun & Bradstreet (DNB), and Cablevision Systems (CVC).
Of course, if indeed this means that buying the most shorted stocks is no longer a "sustainable" strategy, that would be ok as it implies one small step toward returning to a normal, credible, non-manipulated market: something that both we and David Einhorn openly lament. Recall from David Einhorn's Advice On How To Trade This Equity Bubble:
Finally, there are the market participants whose investment process appears to be “bet on whatever has made money most recently.” They’ve noticed that stocks with large short-interest ratios have materially outperformed over the last year and they continue to invest accordingly. When “high short interest” becomes a viable stock-picking strategy and conventional valuation methods no longer apply for many stocks, we can’t help but feel a sense of déjà vu. We never expected to find ourselves in an environment like this again, given the savings that were lost when the internet bubble popped.
Alas, we are smack in the middle of the same bubble once again, and will be until the Chairman keeps playing the musical chairs dance ever faster and faster until finally everyone drops dead.