Big stores head short list

The surprise on the upside put a rocket under the carsales.com share price, lifting the shares 13.5 per cent over two days in a flurried attempt to cover 10 per cent of the stock that had been shorted. Love it or hate it, short-selling is part of the financial system, so regulators need to be on high alert at all times to reduce market abuse and manipulation, including the spreading of rumours to encourage share price collapses.

Short-selling is a practice that has divided the market. Some believe it helps liquidity, helps give pricing discovery to a stock and in some cases expose wrongdoing, as in the case of short-seller Jim Chanos, who was a big short-seller of Enron Corp. Others believe it is nothing more than market manipulation that encourages rumour spreading and should be banned.

According to a compilation of the top 25 most shorted stocks on the ASX by EL & C Baillieu over the past couple of months, retail stocks are the most targeted by hedge funds, and consumer electronics retailer JB Hi-Fi ranks as the No. 1 most shorted stock. Falling consumer confidence and a switch to online is dominating the minds of hedge funds and investors who want to hedge their bets on their investments.

In the current market, where volumes are thin and confidence low, short-selling becomes more powerful because there is little buyer support for stocks. Short-selling where hedge funds, 130-30 funds and others target certain listed companies they believe have further to fall is borrowing stock (usually from super funds) for a fee and then proceeding to sell them, which puts selling pressure on the shares. The theory is that, when the share price falls to a certain level, the short-seller makes a profit because the cost of repurchasing the shares is less than the cost of the initial short-sale.

During the GFC, many countries, including Australia, banned short-selling on the grounds that it exacerbated volatility in the market and damaged investor confidence. In the case of Carsales.com, the hedge funds got caught out last month in what is referred to in the industry as a "short squeeze".

To put it into perspective, in July, Carsales.com was the fifth most shorted stock on the ASX, with more than 10 per cent of its shares in the shorted basket. Since the flurry of short-covering after it posted its results, its ranking is now 16. What is even more interesting is that since this massive short-selling activity has been removed from the stock, its share price has traded above $7.20 a share. (It was trading previously at $6.37).

Concerns were reinforced yesterday with the release of retail sales data for July that showed spending falling 0.8 per cent for the month after a 1 per cent rise in June.

And late last week the latest survey by the NAB Online Retail Sales Index calculated that internet sales now represent 5.3 per cent of the total $220 billion of retail sales. More importantly it showed that domestic online sales year-on-year for June rose 24 per cent and international internet sales rose 29 per cent.

One of retail segments taking the biggest hits is consumer electronics. It goes along way to explaining why more than 20 per cent of JB Hi-Fi's stock was shorted in July and August. Hedge funds are punting that the bad news is not over for JB Hi-Fi. Ditto for the Reject Shop, which is the fifth-most shorted stock, followed by Myer at number six, Harvey Norman at number nine and David Jones at number 10.

Harvey Norman founder and major shareholder Gerry Harvey tried to draw a line in the sand after the franchising giant suffered a 32 per cent fall in profit, but a key issue is its property portfolio, which many believe needs to be written down further than the $36 million it was this time around.

Shorting activity has increased in media, consumer discretionary and some mining stocks, including Iluka Resources, Alumina, Linc Energy and Lynus Corporation.

In media, Fairfax Media was the third-most shorted stock in July and August, with 11.12 per cent of its issued capital reported as shorted stock. Ten Network was the 25th most-shorted stock, with 5.27 per cent of its stock shorted. Another heavily shorted stock is Fortescue Metals, which is not surprising given the recent and sudden fall in iron ore prices, which is raising questions about Fortescue's earnings outlook, debt and ability to fund planned expansion.

Since the start of July, the shares have fallen from $5 a share to close yesterday at $3.56.

The list from EL & C Baillieu reveals that in July Fortescue ranked 21st, with 5.91 per cent of its stock shorted. By August, this had risen to 7.21 per cent, making it the 15th-most shorted stock.

With fears that the wheels are coming off the mining sector, there is little doubt that more mining stocks will become the targets of hedge funds, which will further suppress their stock prices.