The stock market has staged an impressive rally as 2023 gets underway with the S&P/TSX Composite Index climbing by nearly 7 per cent over the past 30 days.
Although there are classic signs of impending recession – such as inverted yield curves and contractionary readings in the U.S. purchasing managers’ index for manufacturing – some investors seem to have bought into the optimistic view encouraged by developments such as falling inflation and the shedding of stringent pandemic controls in China (which improves prospects for an upturn in global growth).
Leading the recent rally, however, are heavily shorted stocks. The 20 stocks with the highest percentage of float short, for example, have appreciated more than 21 per cent in the past month. Year-to-date gains in the Toronto Stock Exchange may thus be getting a boost by a short squeeze that is pressuring short sellers to close out their positions.
The 20 most shorted companies by percentage of float (Jan. 25)
Some analysts think the short squeezes could continue a while longer. Take Canada Goose Holdings Inc. (GOOS-T), which has emerged this month as the most heavily shorted stock on the TSX with 26.8 per cent of its float sold short, according to S3 Partners data.
The maker of the iconic brand of parkas and winterwear suffered erosion in its margins last year due to inflationary cost pressures but now that COVID-19 controls have been lifted in China, Canada Goose is positioned for “an expected recovery from sales in Asia,” argues BOOX Research analyst Dan Victor on seekingalpha.com. He expects the stock price to be a third higher in a year, as “the shorts should be looking to close their short bets on the company as the outlook for sales and earnings accelerates.”
Companies with a high percentage of float short are particularly at risk of turning into, or extending, short squeezes if the cost for a short seller to borrow their shares is high. On the 20 most-shorted list, the following securities had high costs to borrow: Lion Electric Co. (17.9 per cent), Purpose Bitcoin ETF (16.6 per cent), Briacell Therapeutics Corp. (31.2 per cent) and Hut 8 Mining Corp. (29.4 per cent).
Activist short sellers
When activist short sellers take positions in stocks, they publish bearish research reports on the targeted companies. According to data firm Breakout Point, there were eight such reports on Canadian companies in 2022, compared to 12 in 2021.
Canadian companies targeted by activist short sellers in year to Dec. 31, 2022
Globally, there were 113 activist short seller reports, with 77 of them focused on U. S. companies. There were also bearish bets in Europe (12), China (8) and other countries (8).
The 113 short positions worldwide were down an average -31 per cent after the release of activist short sellers’ reports. The average decline in the 8 stocks targeted in Canada was 46 per cent, the most of any country and considerably more than the Toronto Stock Exchange’s decline of 6.2 per cent in 2022.
Most expensive stocks to borrow
Since short sellers need to borrow a stock before they can sell it short, another indicator of short-seller sentiment is the cost to borrow shares. A stock with a high cost to borrow usually means that short sellers are bearish on the company. If the cost is extremely high, short sellers might feel pressure to buy back shares and return them to the lender. Here are the Canadian companies with the highest rates, according to iborrowdesk.com.
Most expensive stocks to borrow in Canada (as of Jan. 25)
1) Some short positions may reflect, in part or whole, hedging/arbitrage positions – so they are not entirely bearish bets.
2) Short positions in inter-listed stocks were summed across exchanges in Canadian dollars.
3) When an investor purchases stock that was sold by a short seller, it creates a synthetic long position; if these long positions are not included in the float count, the percentage-of-float-short metric can be overstated – however, most of the time, the magnitude is not significant.
4) The percentage of float short for ETFs is impacted by the ETF mechanism for creating/redeeming units, which results in almost daily changes in the number of units issued. As a result, the percentage of float short for ETFs may be more volatile than for stocks.