Short sellers looking to take profits will wait until after the New Year to cover
Investors holding very profitable positions will astutely wait until after Jan. 1, 2022 to sell. This postpones paying taxes on the profits by a year. Short sellers, on the other hand, who have made money will wait until after the New Year to cover their short position. This can help us identify stocks with an increased chance to rally early in the next year. In the analysis below, I’ll first look for evidence that we can identify early year short-covering rallies. After that, I'll show a list of stocks that might benefit from this phenomenon.
The Evidence
Based on the data below, we can find stocks with an increased chance for an early-year rally. The data below look back over the past four years. It separates stocks with high short interest (above 10% of float) and then breaks those down further by their year-to-date return. The theory is that highly shorted stocks which are down a lot will have the best chance to benefit from an early-year short-covering rally. This stems from short sellers holding off until after the New Year to recognize their profits by covering.
The highly shorted stocks that were down big for the year performed the best in the first week of the New Year. They gained an average of 5.43% in the week. The most noteworthy stat in the table below, in my opinion, is the percentage that beat the SPDR S&P 500 ETF Trust (SPY), an ETF for the S&P 500 Index (SPX), which I’m using as a benchmark. Two thirds of the stocks in that highly shorted and down big column beat the ETF. The stocks in that first column was the best performing group based on every metric below.
This next table shows the data for just the most recent year. The highly shorted names that were down the most were not the best group, but the average return of those stocks beat the SPY return of 1.4% and it also beat the small-cap iShares Russell 200 ETF's (IWM) return of 6.2%.
Potential Short-Covering Rallies for Early 2022
Finally, the most important part. Below is a list of 25 stocks that are down at least 10% in 2021, with at least 10% of their float sold short. These stocks meet the criteria above for highly shorted, beaten down stocks that could benefit from early year short covering. Based on the analysis above, these stocks have an increased chance at outsized gains in the first week of the New Year. It’s a good stalking list for short-term trades in the first week or so of next year. Additionally, it might be a confirmation indicator for those considering purchasing a technically weak stock.
