This is a special edition of Short sales on the TSX: What bearish investors are betting against. It seeks to provide additional and timelier insight on short sales in Canada, as a supplement to the short-sales update that regularly appears near the end of the month. Included in this edition is coverage of: short-squeeze candidates, the utility of other data sources and analysis of heavily shorted exchange-traded funds (ETFs) – notably the BMO Laddered Preferred Shares ETF.
Short squeeze candidates
Stocks with large short positions underperform the market on average, according to academic research. However, there are times when they may outperform due to short squeezes. The latter occurs when some news or event causes short sellers to hurriedly buy back shares and return borrowed shares, thus precipitating an upward spike in the price of a stock.
According to S3 Research, the prime conditions for a short squeeze in a stock are: a large short position, heavy mark-to-market losses imposed on short sellers due to an uptrend in share price, and high costs to borrow the shares. On this basis, the following table lists the top ten short-squeeze candidates among mid- and large-cap companies in Canada.
The year-to-date losses for these stocks have been persistent, with the losing trend extending up to the past month. “These stocks are very susceptible to short squeezes, especially those with high stock borrow rates like Lithium Americas and AutoCanada,” declares Ihor Dusaniwsky, Managing Director of S3 Partners.
The website of the Investment Industry Regulatory Organization of Canada (IIROC) publishes the Consolidated Short Position Report (CSPR), which shows the number of shares sold short for individual TSX companies on the 15th and last day of each month (with a publishing lag of several days). It does not include foreign short sales of interlisted Canadian stocks. But for stocks trading only in Canada, IIROC’s report can provide a full picture of short interest.
ETF short sales
Since most Canadian exchange-traded funds (ETFs) trade only on Canadian exchanges, IIROC’s data can be used to explore bearish sentiment at higher aggregation levels, such as industry sectors and asset classes. The top ten Canadian ETFs by number of units short are listed below.
Four economic sectors, energy, banks, REITs and marijuana, have relatively high bearish bets – as signalled by the number of shares sold short on the following ETFs: iShares S&P/TSX Energy, BMO Equal Weight Banks, Horizons S&P/TSX 60 and Horizons Marijuana Life Sciences. Backing up this bearish interpretation are relatively high readings for two other indicators: the percentage of units sold short and the cost to borrow the units.
The asset class of preferred shares makes an appearance in the form of the BMO Laddered Preferred Shares ETF (ZPR). Its short interest has been the second or third highest of ETFs for the past year or so, fluctuating within a range from 11.6 million to 20.9 million units.
ZPR has gained approximately 50 per cent gain since the stock-market plunge of mid-March. This appreciation reflects, like the rest of the stock market, the government’s massively stimulative response to the coronavirus threat, particularly the dramatic lowering of interest rates.
A recent bullish factor for ZPR’s pricing has been the emergence of a new security, the “limited recourse capital note” (LRCN). For the banks, it’s a cheaper way to raise capital than issuing preferred shares; the result for the latter is a curtailment in supply due to reduced issuance and increased redemptions.
The relative stability of ZPR’s short position in volatile stock markets suggests that it was put in place mainly for hedging purposes. Jeffrey S. Herold, CEO of investment firm J. Zechner Associates Inc. confirms this when he says, “Dealers hedging individual preferred holdings, derivatives and structured notes account for the majority of the shorts”
James Hymas, President of Hymas Investment Management Inc., reinforces this view, declaring that the “shorts are probably market makers.” He says retail investors like to buy ZPR more than individual preferred shares, so there are forces pushing ZPR to a premium over its basket of preferred shares. With market makers often selling short to fulfill investors' buy orders, ZPR’s market makers may not want to cover their shorts with purchases of ZPR (as units become available) but seek a better spread through hedging with a basket of individual preferred shares.
Short sales of market ETFs
The short position in the iShares S&P/TSX 60 ETF is often used as an indicator of bearish sentiment at the market level and a predictor of its direction. As can be seen in the graph, the number of units short in the XIU continued to tumble up to Aug. 31.
Many short sellers were getting margin calls as the market continued to rise to the end of August, and they chose not to deposit the required capital to maintain their positions. But the sharp sell-off in early September may have emboldened some of them to jump back into the market.
There are other market-level ETFs, such as the iShares Core S&P/TSX Composite (XIC), Horizons S&P/TSX 60 (HXT) and BMO S&P/TSX Composite (ZCN) ETFs. A more accurate gauge of market-level bearishness could thus be the sum of short sales for all the market ETFs.
This sum is compared to XIU’s short-sale count in the above graph. The trend in the two series is similar, so XIU appears to have been a reasonable proxy for changes in bearish sentiment. Nonetheless, some fine tuning is possible with the sum of short sales for all market ETFs.
Larry MacDonald is an author, journalist and economist. He can be reached at firstname.lastname@example.org
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