Anytime the market is near a peak, investors question valuations. And short sellers often target stocks that have gone up a lot relatively quickly.
They’re essentially following one of Newton’s famous physics laws — to every action, there is an equal and opposite reaction. In other words, what goes up must come down.
Here’s a quick tutorial on short selling. Investors borrow a stock and sell it, with the hopes of repurchasing it at a lower price and pocketing the difference. The more a stock goes down, the cheaper it becomes to repurchase it and return it to the lender.
Shorts often wind up noticing bad news before the rest of the market, just like Steve Eisman, the hero of the book “The Big Short” about the subprime mortgage crisis. (His name was changed to Mark Baum in the movie.)
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But many short sellers have been focusing their attention on stocks that have already been pummeled. These bearish investors must believe that the worst is not over yet.
Bet against Oprah?
Ihor Dusaniwsky, head of research for S3 Partners, a financial analytics firm that tracks short selling, said two current favorites of short-sellers are Weight Watchers ()and Whole Foods ( ).
Weight Watchers stock has already plunged more than 55% this year. It’s a bit curious since the company’s woes have already made a lot of short-sellers rich.
But Weight Watchers has continued to struggle even though Oprah Winfrey bought a stake in it last year and has become its new celebrity spokesperson. The company’s CEO announced earlier this week that he will step down at the end of the month.
“The surge in short selling of Weight Watchers surprised me a bit,” Dusaniwsky said. “I thought more investors would take profits and get out of that trade. But even in the past month, more are piling in.”
Shorting kale and quinoa.
The company is still suffering from last year’s price-fixing scandal. Sales have been weak. There’s a lot of skepticism about the company’s newer urban stores that are targeting Millennial shoppers. And competition remains intense.
So it looks like investors still don’t have faith that the company can turn things around anytime soon.
“Kroger is hurting Whole Foods. The expansion plans are a challenge as well. And who wants to spend $6 a pound for apples?” Dusaniwsky said.
He was exaggerating a bit about the apples. A pound of Fuji apples at the Whole Foods closest to me costs just $2.49 a pound — but are currently on sale for $1.49. Still, the company’s Whole Paycheck reputation has lingered.
Close Sesame on Alibaba?
So short sellers may be picking on stocks that are down. But they are targeting some big market winners too.
Chinese Internet giant Alibaba (BABA, Tech30) is up nearly 30% this year. And well-known hedge fund manager Jim Chanos has talked about Alibaba as a top short pick of his lately.
Dusaniwsky said he’s surprised that many investors are betting against Chanos, given his successful track record. Alibaba also faces a big challenge from the Chinese social media giant Tencent (TCEHY).
Hey St. Jude. Don’t make it bad.
Medical device company St. Jude Medical () is another hot company that has attracted more shots thanks to a prominent market bear.
Carson Block, who runs the research firm Muddy Waters, has recommended shorting St. Jude due to concerns about the company’s pacemakers and defibrillators, which he alleges can be hacked. (Didn’t that happen on “Homeland?”)