REPEAT Rudi’s View: ASIC’s Stock Momentum Indicator

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(This story was originally published on Wednesday, 10 November, 2010. It has now been repeated to make it available to non-paying members at FNArena and readers elsewhere).

By Rudi Filapek-Vandyck, Editor FNArena

Regular readers of my market reports and analyses know I use a variety of indicators to tell me what is happening underneath the share market's surface; from stockbroker upgrades and downgrades, to consensus price targets, to trends in earnings and growth forecasts. Meanwhile, I also pay close attention to what other experts' findings are, including the occasional technical analyst.

The main lesson I have learned over the years is to not be rigid when using any of these indicators. Sometimes the market simply is not in the mood, other times it just wants to do its own thing. Between August and this week, the market pretty much danced to the tune of more quantitative easing in the US, and little else. This is why you haven't been receiving any updates from me on the ongoing sizable gap between recommendation downgrades and upgrades, or on the fact that Australia is still lagging the rest of world when it comes to trends in earnings forecasts.

There is a time and place for everything.

I did pick up, however, that the disconnect I have observed in the share market with some of these indicators is now also featuring in market commentary elsewhere. Look, for example, at the charts that were printed on page 37 in today's Australian Financial Review newspaper:

Much more interesting, however, is the fact that analysts at RBS have reignited my interest in the daily short selling data as published by ASIC. In the US, where short selling activity is more widespread and accepted as part of overall market activities, more data and information is available for updates and for analysis. Past analyses of these data have already proven that paying attention to overall activity and trends at the short end of the market can be very useful for investors in the share market. In Australia, I readily admit, I haven't paid much attention ever since ASIC started collecting and reporting its own data.

This is one of the legacies from when shareholders in banks were publicly screaming murder for all the wrong reasons during the GFC. ASIC readily admits on its website the data are likely to be flawed, incomplete and not necessarily an indication that investors are positioning for a fall in share price, and this pretty much sums up why I haven't been interested in these daily reports so far. Recent analysis by RBS suggests, however, there's potentially more value in these daily ASIC reports than one would initially suspect.

RBA analysts too, readily admit their own work needs more depth and follow-up, but initial data analysis seems to indicate that paying attention to which stocks stand out in overall shorting activity might well pay off as, in RBS's observation, shorters seem to have a habit of picking the overvalued stocks, or those about to suffer from downgrades and from lowered earnings expectations. This makes sense, because one would assume those who go short on a particular stock (meaning: taking a position to benefit from a fall in share price) would be looking for a reason to do so.

As such, RBS has observed that stocks that outperform the market for a while, subsequently tend to see an increase in short positions in these ASIC updates, after which these stocks usually go through a period of underperformance. Makes all perfect sense. Note that nobody, RBS included, is drawing a causal relationship. These stocks do not underperform because a limited group of investors went short on them, it's simply a matter of reading the market well, and picking the right stocks that are likely to run out of puff.

Thus a spike in short positions should indicate a weaker share price ahead?

If only life were that simple. The most shorted stock in the Australian share market is Fairfax Media ((FXJ)), but this is one that falls in the "I am different" category. FNArena explained earlier this year why these short positions should not be read as a warning signal, see "Fairfax And The Big Short", June 24, 2010.

November updates by ASIC also show increased short positions for Rio Tinto ((RIO)), but practically none for BHP Billiton ((BHP)). This seems to me more a play on BHP making up for some lost territory related to a likely failed tilt at Potash Corp, not so much speculation that Rio Tinto shares will weaken this month (though that might happen too).

Both examples should already be clear: don't simply assume that increased numbers in the daily ASIC report automatically means the share price is going to dive.

Analysts at RBS found the data reported by ASIC can be a useful tool as increased short positions can be an indication that a given stock is about to start underperforming. Examples that came out of the RBS analysis include JB Hi-Fi ((JBH)), Boral ((BLD)), Campbell Bros ((CPB)), Sims Metal ((SMS)) and West Australian Newspapers ((WAN)).

It is not so difficult to see why these companies would have been picked by the shorters. JB Hi-Fi was arguably too expensive a few weeks ago (challenging the consensus price target) and with ongoing deterioration in domestic economic data, plus another surprise rate hike by the RBA, the market is understandably sceptical about the prospects for this year's Christmas sales.

Boral remains in essence a sad story about a bad housing market slump in the US, and a bad building market in Australia on top.

Campbell Bros is one of those stocks that performed very well, but now approaching the consensus price target, and thus probably in need of a pause. The stock also received a recommendation downgrade, to Neutral, from UBS. Note the share price hasn't retreated as yet, but I wouldn't be surprised if it did.

Sims Metal shares once were expensive and then earnings started disappointing. The market clearly doesn't like steel stocks at the moment, see for example BlueScope Steel ((BSL)) and OneSteel ((OST)) at the top of the R-Factor rankings this month. Sims Metal shares haven't done much since July.

WA News shares are near consensus price target, again indicating a valuation problem. Recent results disappointed the market and management gave a rather cautious outlook for the year. Again, it would seem there are valid reasons to expect WA News shares might be heading lower rather than higher in the short to medium term.

All in all, it would seem, these ASIC updates (released at a delay of a few days) don't exactly reveal information that will blow one's socks off, but it could pay off to have a look first before buying into yesterday's outperformer, just in case the shorters are telling you they think the share price is about to head south.

I noticed, for example, Elders ((ELS)) is amongst those companies with elevated shorters interest. The company's share price was already under some downward pressure, but then management issued another disappointing market update this week.

I also saw there seems to be a general elevated level of shorts for discretionary retailers. Apart from the above mentioned JB Hi-Fi, there's also Myer ((MYR)) and David Jones ((DJS)).

And then there's Aristocrat ((ALL)), which seems to have been carrying higher interest from shorters since a while, but the share price has shown signs of bottoming recently and has started to rise slightly. It is true, this year should be a horrible year for the company and at a forward multiple of 20 the valuation seems high, but then 2011 should see a massive improvement. Consensus currently predicts a jump in earnings per share of no less than 164%. Are the shorters signaling more downgrades are yet to come? On the back of continued USD weakness maybe? Or is there maybe another factor in play?

Readers who want to keep track of the daily ASIC reports can do so via the ASIC website: http://www.asic.gov.au/short-position-reports

P.S. I – All paying members at FNArena are being reminded they can set an email alert for my Rudi's View stories. Go to Portfolio and Alerts in the Cockpit and tick the box in front of 'Rudi's View'. You will receive an email alert every time a new Rudi's View story has been published on the website.

P.S. II – If you read this through a third party source and you cannot see the charts at the beginning of the story, we apologise but technical limitations are to blame.

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