MARKETS SPECTATOR: Caught short

In looking back at the earnings season that has just finished, I thought it was topical to have a look at some of the best performers as measured by the announcement effect. The ‘announcement effect' looks at the stock performance three days after its earnings were released.

Below is a list of some of the better known top performers.

	Announcement effect (share price move 3 days after earnings released)	Short interest
Bradken	23.44%	7.00%
Bluescope Steel	16.50%	0.10%
Pacific Brands Group	14.40%	2.00%
Southern Cross Media	14.20%	2.16%
JB HiFi	14.20%	25.24%
Seek	13.45%	7.30%

Interestingly, as you can see in the table above, 50 per cent of the names above have big ‘short' positions in the stock, meaning that some hedge fund or the like is betting on the share price going down. This is one of the big reasons behind the huge jump in share price after their results were released.

Obviously the results have come out better than the market had been expecting, for whatever reason and it has forced those shorters into reassessing and possibly exiting their position.

The above chart of JB Hi-Fi, which has the biggest short position in the Australian market is a classic example of a ‘short covering' rally.

Since the short interest (orange line) peaked, the underlying stock price has surged 32.75 per cent as those participants that had bet against the company were forced to try and close out some of their positions in a market that was already surging.

JB's result was quite encouraging, meaning that it attracted a lot of buyers into the stock on the premise that we'd seen the bottom of the current retail cycle. Amongst all this fresh buying, there were ‘shorters' trying to frantically get out of a losing trade in a market that had just jumped higher. Basically, it's like pouring fuel on to a fire and it ignites the rally even more.

And for those that hold long positions, only 26 per cent of the short trade has been closed out meaning there is still plenty of buying to come. Needless to say, it's been an ugly month for shorters.

Interestingly, in a couple of research reports looking back on the earnings season, a number of brokers remarked that although the earnings season had been better-than-expected, analysts continued to downgrade forecast earnings and company outlook statements continued to be cautious.

Through my bullish glasses, this is very encouraging. What it tells me is that despite the recent rally and signs of improvement, much of the professional investment community continues to set the ‘expectations bar' low. While this is occurring, it becomes much easier for stocks to beat expectations and hence continue to move push higher.