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This soul-destroying trade could be about to make a comeback

The biggest losers from the reporting season weren’t the miners. They were the short-sellers as some of their biggest bearish bets failed to play out in what was a pretty upbeat profit environment.

However, these Doctors of Gloom may yet get their revenge given growing concerns that the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) is primed for a pull-back given the growing macro-economic risks and the strong run on the market.

It’s this strong run that is causing most short-sellers to be nursing losses with the most shorted stocks on the top 200 index such as JB Hi-Fi Limited (ASX: JBH), Metcash Limited (ASX: MTS) and Domino’s Pizza Enterprises Ltd. (ASX: DMP) outperforming the broader market last month.

Short-sellers are those who sell borrowed stock in the hope of buying it back at a lower price later to profit from the difference. UBS noted that many of the hot favourite short-sold candidates have either posted better-than-expected results or have benefited from merger and acquisition (M&A) activity with TPG Telecom Ltd (ASX: TPM) the most obvious example.

Short on Profits: Performance of the most shorted stocks vs. the ASX 200

But the pain for short-sellers isn’t confined to Australia. The longest bull-run on the US S&P 500 index has also left many hedge funds banking on a market rout in the red. Their favourite short-selling targets include the high-flying tech sector that includes Amazon.com, Inc., which just became the second US$1 trillion market cap company after Apple Inc.

These have been dangerous times to be short-seller.

However, not all short-bets on the ASX have been disasters. In fact, if we looked at the stocks that have seen a marked increase in short-selling interest right before the August reporting season, many have actually paid off for the bears.

Shares in fleet management group Eclipx Group Ltd (ASX: ECX) saw the biggest percentage increase in the amount of stock that was short-sold from the end of July to the middle of August when the reporting season ramped up.

The amount of its shares held by short-sellers jumped 2.5 percentage points over that two-week period and has continued to climb since, as its share price slumped 13% over the past month.

Other stocks that saw a more than 1% increase in short-interest from end the end of July to middle of August have also fallen into the red. These include plumbing solutions company Reliance Worldwide Corporation Ltd (ASX: RWC), milk products maker Bellamy’s Australia Ltd (ASX: BAL) and crop protection products group Nufarm Limited (ASX: NUF).

The only exception is superannuation services company Netwealth Group Ltd (ASX: NWL) as its share price rallied 12% even as short-interest in the stock increased 1.7% to 6.2%.

Most of these stocks don’t make it to the list of the most heavily shorted stocks. As I mentioned, many of those stocks have so far been outperforming.

However, if I am right and the ASX 200 starts retreating further from its more than 10-year high over the coming weeks, some of these losing bets may yet produce a winner.

Top 3 ASX Blue Chips To Buy In 2018

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Motley Fool contributor Brendon Lau owns shares of Nufarm Limited and TPG Telecom Limited. The Motley Fool Australia owns shares of and has recommended TPG Telecom Limited. The Motley Fool Australia has recommended Domino's Pizza Enterprises Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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