Short-selling interest in the consumer staples and energy sectors is at its highest levels in more than five years, according to a report by Morgan Stanley.
The report, covered in Fairfax media this morning, shows that short interest in the banks has declined in recent months, while the number of short sellers in consumer staples and energy has risen to record levels over the past year.
Short selling occurs when an individual borrows shares to sell them at a given price, then buys them back at a lower price, returns them to the lender and pockets the difference. Stocks with a high level of short-seller interest often fall very rapidly after bad news as your garden variety selling combines with rampant opportunism to force a stock downwards.
We saw this very recently with Metcash Limited (ASX: MTS), which fell 15% after a profit downgrade earlier this month. Metcash was also one of the most shorted stocks according to Morgan Stanley.
Morgan Stanley is underweight the consumer staple sector in general, predicting that majors Wesfarmers Ltd (ASX: WES) and Woolworths Limited (ASX: WOW) will struggle to grow earnings per share as a result of competition from Aldi and Costco in the future.
While short interest in the major supermarkets isn't as big as Metcash at the moment I think it could rise sharply in the future, as investors revise their expectations downwards.
Other stocks experiencing a rising level of short interest are junior oil/gas producers Beach Energy Limited (ASX: BPT) and Drillsearch Energy Limited (ASX: DLS), as well as Myer Ltd (ASX: MYR), and Worleyparsons Limited (ASX: WOR).
Beach and Drillsearch short sellers are clearly trading off the expectation that low prices will decrease profits and impact the company financially, while thin volumes also increase the likelihood of a greater fall and more profit.
The same can be said for Worleyparsons; with mining sector investment continuing to slow, there's still no end in sight to the profit downgrades. Myer is another obvious mark as the retailer's continuing struggle with declining revenues has seen its share price dwindle in recent times.
Investors should remember that there is significant extra risk and volatility involved with taking on a stock with a high number of short sellers like Myer, Worleyparsons, or Metcash. The risk rises if it's a 'turnaround' stock because as Warren Buffett famously noted:
"Turnarounds seldom turn."
