Repeatedly burned, short sellers avoid momentum stocks

Updated: Tuesday October 22, 2013 MYT 6:55:17 AM

Repeatedly burned, short sellers avoid momentum stocks

NEW YORK: Even as some of Wall Street’s biggest trading favorites – considered by many to be massively overvalued – report earnings this week, short sellers are staying away. Shorts have become gun-shy as the market has continued to rally, making bets against high-flying stocks like Netflix or Tesla very expensive ones. Steep losses have been amplified by “short squeezes,” where shorts are forced to cover their bets to prevent further losses.The current caution underscores how difficult it has been to score with negative bets in an environment fueled by Federal Reserve stimulus. Even companies that have seen meteoric rises, giving them stretched valuations, have been essentially immune to the downside.

That’s resulted in a lousy year for hedge funds with a short bias strategy – those that take a net short position in the market. Through September those funds were down more than 13 percent for the year, according to Hedge Fund Research.

“The people who have tried to short have been annihilated up to this point. I’m sure some is still going on, but they’re being very cautious. Even gambling that there will be corrections after earnings has become risky,” said Angel Mata, managing director of listed equity trading at Stifel Nicolaus Capital Markets in Baltimore.

VALUING NETFLIX

One of the market’s biggest momentum names is Netflix Inc <NFLX.O>, up 260 percent this year. By many metrics it is overpriced, with a price-to-earnings ratio of 105.48 that far eclipses the 16.25 ratio of its peers.

It is the third-most-overvalued stock in the S&P, according to StarMine’s intrinsic value, a calculation of where a stock should trade based on its most likely growth trajectory over the next decade or more. StarMine puts Netflix’s value at $50.04 a share; it currently trades at $333 a share.

Given that, one might expect shorts to pounce on a name that appears ripe for a pullback, especially ahead of results due after Monday’s close. They have not. The percentage of Netflix’s shares available for shorting that are currently being used for short bets is a mere 5.5 percent – lower than the market average – compared with 28 percent at the beginning of August, according to Markit.

“If you ask 10 people, nine would say it’s overvalued, but if you ask those nine if they would short it, none of them would,” said Stifel’s Mata. “Yes, it might trade lower if earnings disappoint, but likely it’ll go sideways for a while and then go back up. There’s nothing to be gained in trying to short it.”

YEAR’S BIG WINNERS

Netflix isn’t alone among the year’s big winners reporting results this week. Electronic components maker Molex Inc <MOLX.O>, up 41 percent in 2013, has seen the percentage of its shares available for shorting that are being used for such bets fall to 6.8 percent from more than 27 percent in the first week of July.

Short interest is a bit higher in TripAdvisor Inc <TRIP.O>, with 22.5 percent of shares available for shorting being borrowed for those bets, but that’s still a sharp decline from a 2012 peak of nearly 50 percent. TripAdvisor, up 71 percent in 2013, reports on Wednesday.

Even Tesla Motors Inc <TSLA.O>, perhaps the year’s most dramatic momentum name, with gains of 441 percent, has seen short bets fall off. There’s still a dedicated base of shorts there – 52 percent of the shares available for this are being shorted, but it was at 75 percent in May. Tesla reports results in early November.

Joe Saluzzi, co-manager of trading at Themis Trading in Chatham, New Jersey, said shorts were having more luck betting against the year’s weak performers, or value stocks like IBM <IBM.N> rather than momentum names.

IBM fell sharply on October 17, a day after reporting weak quarterly revenue, extending its decline for the year. Expedia Inc <EXPE.O>, which is down 21 percent this year, has seen short interest rise 7.6 percent over the past two weeks.

“The thing about this issue is that the people who want to short momentum names will eventually be proven right,” said Saluzzi. “When Netflix or Tesla break, they’ll break hard. We just don’t know where in the cycle they are, and in the meantime shorts are being carried out on stretchers.”

The S&P 500 <.SPX> is up more than 22 percent in 2013, but these shares have far surpassed that, owing to strong growth and buyers eager to chase after winning stocks.

Bill Fleckenstein, president of Fleckenstein Capital Inc in Seattle, said he shut down his short fund when the Fed first announced its stimulus program “because I knew it would be difficult to make short plays work in that kind of environment.

“However,” he added, “I never imagined it would make shorting as hard as it has become. In this world, just because something is stupidly expensive doesn’t mean it will go down.”- Reuters