It may seem hard to believe, with the big S&P 500 index just 2% away from hitting new all-time highs, that investors actually hate stocks right now. But it's true.
As I write, U.S. total short interest -- a measure of the bets being made on a decline in the stock market -- is sitting at post-2008 highs. That's not just some sort of flaky sentiment reading either; it measures actual money being bet on lower stock prices. In order to find a time when investors hated the stock market more, you'd have to rewind the tape all the way to September 2008, during the depths of the financial crisis.
To many investors, that probably looks like yet another red flag for stocks. But to any contrarian worth his salt, being short actually looks like a pretty crowded trade. And, more often than not, the stocks that investors hate the most are the very same ones that you should think about buying.
That's not just my opinion. The data bear it out as well. Over the last decade, buying the most hated and heavily shorted large and mid-cap stocks (the top two quartiles of all shortable stocks by market capitalization) would have beaten the S&P 500 by 9.3% each and every year.
Too much hate can spur a short squeeze, a buying frenzy that's triggered by short sellers who need to cover their losing bets to exit the trade.
For our purposes, one of the best indicators of just how high a short-squeezed stock could go is the short interest ratio, which estimates the number of days it would take for short-sellers to cover their positions. The higher the short ratio, the higher the potential profits when the shorts get squeezed.
Today, we'll replicate the most lucrative side of this strategy with a look at five big-name stocks that short sellers are piled into right now. These stocks could be prime candidates for a short squeeze in the months ahead.
Up first on our list of hated stocks is Deere (DE - Get Report) . At a glance, it's not terribly hard to figure out what's frustrating investors about Deere. Since January, this heavy equipment manufacturer has shed more than 10.6% of its market value, lagging the market by a wide margin. In turn, shorts have been chasing the weakness in Deere, piling up this stock's short interest ratio to 12.85. That means, at current volume levels, it would take nearly three weeks of buying pressure for short sellers to cover their bets on Deere.
Deere is one of the world's largest manufacturers of agricultural and construction machinery. Even if you've never stepped foot on a farm before, there's no doubt you know the Deere name -- or its signature green color. That household-name status and sterling reputation translates into the appeal for Deere's big machines -- and its ability to collect premium pricing. Today, Deere commands more than half of the North American agriculture market.
That big exposure to ag has been a soft spot in Deere lately. Because soft commodity prices have been under siege amid a strong dollar in the last several years, Deere's biggest customers are feeling pricing pressure. That headwind is offset somewhat by the record low interest rates in the market today -- and Deere's ability to capitalize on them thanks to its own captive finance unit (much like an automaker).
Despite investor concerns, Deere continues to make money in this environment (and trade for a low earnings multiple). That price tag helps to make this industrial stock a short squeeze candidate this winter.
Meat giant Tyson Foods (TSN - Get Report) , on the other hand, is enjoying some strong performance in 2015 -- much to the chagrin of short sellers. Tyson's shares have appreciated by more than 25% since the start of the year, outperforming the broad market by a big margin. As I write, Tyson's short interest ratio remains in the double digits at 10.02, indicating more than two weeks of buying pressure would be needed for short sellers to cover their bets on this stock.
Tyson Foods is one of the biggest producers of chicken, beef, pork and prepared food products. Besides its namesake brand, Tyson also owns Hillshire Farm, Jimmy Dean and Ball Park, among others, through its acquisition of Hillshire Brands last year. Much of the selling pressure on Tyson is tied to its exposure to commodity meat prices, and low inflation has kept margins pressured for food producers. The full integration of the Hillshire scale into Tyson's operations, plus growth internationally, where meat consumption per capita is increasing, are the big upside catalysts in this stock.
Size matters in the meat business. Tyson's ability to buy inputs in large quantities helps it garner pricing power over suppliers, and a large distribution network helps the firm spread other costs across more volume. Technically speaking, Tyson broke out hard on the firm's fourth quarter earnings release last month, and that could help spur some extra short-covering as shares hover at new 52-week highs this December.
2015 has provided some strong tailwinds for shares of payroll services firm Paychex (PAYX - Get Report) . Consistent improvements in the jobs market have driven up the number of employees on the books -- and that's increased the service revenues for Paychex in kind. Still, short sellers have a perennial hatred of this stock -- enough to shove shares' short interest ratio up to 10.3.
Paychex provides payroll services for more than 590,000 customers, mainly small and medium-sized businesses. The firm helps those smaller firms navigate the labyrinth of tax and compliance issues involved in paying employees, collecting profits in the process. To counter the squeeze of the financial crisis earlier in the decade, Paychex focused on expanding its business to other outsourced HR functions, including 401(k) administration and worker's comp insurance.
The prospect of higher interest rates from the Fed provides a bullish catalyst for shares of Paychex. That's because Paychex has historically earned substantial income from float interest (the interest money it earns on massive payroll accounts between the time that employers deposit funds and employees cash their checks). But with rates held near zero for the past five years, that revenue stream has dried up. Even a small increase in rates could parlay into a big revenue enhancement at Paychex this winter.
$18.6 billion hotelier Marriott International (MAR - Get Report) weighs in with the highest short interest ratio this week: 15.9. That means that it would take more than three week of buying pressure for short sellers to cover their bets against this stock. And ironically, that hefty shorting is arguably a lot more tied to the firm's huge $13.4 billion acquisition of Starwood Hotels & Resorts (HOT) than it is to investors betting on Marriott's demise.
Ultimately, it doesn't matter why short sellers are packed into a stock -- only that they are.
Marriott is one of the biggest hotel chains on the planet, with more than 4,300 properties worldwide. The firm's biggest brands include its namesake Marriott and Courtyard banners, in addition to more niche names like Ritz-Carlton. That portfolio of brands and properties is set to expand dramatically with the addition of Starwood, a deal that's expected to close next summer.
The vast majority of Marriott's properties are franchised by third-party owners and managed by the firm. That arrangement means that someone else bears the big capital costs of buying, building and maintaining properties, and Marriott collects recurring fees for its efforts. That arrangement also gives Marriott better control of its brand, because it's the one running those franchised hotels, not the franchisee.
Marriott holds short-squeeze potential as we head into 2016.
Last up on our list of heavily shorted stocks is auto retailer CarMax (KMX - Get Report) . CarMax is one of the largest used car sellers in the country, with a network of 144 superstore locations spread from coast to coast. By pulling some of the consumer risk out of the used car market, CarMax is able to collect premium pricing for its vehicles -- and it's well-positioned for an aging U.S. vehicle fleet.
CarMax does sell new cars as well, but they only account for about 2% of total revenue. That's actually a very good thing too. Used cars sell for significantly higher profits per vehicle than new cars do, and CarMax's used offerings (which are late model and low-mileage) tend to sell for even fatter premiums thanks to value-adds like the firm's warranty and extended service plans. As consumers try to wring more life out of their automobiles (the average car on U.S. roads today is older than ever before), the relatively lower entry price of CarMax's used offerings makes upgrading look more palatable.
Because of its scale, CarMax is able to provide in-house financing that effectively makes it the only used car shop in town with its own financing arm. The firm finances about 40% of its sales in-house, giving the salespeople more leverage to make deals work and collecting bigger profits in the process.
Currently short sellers have bid CarMax's short interest ratio to 11.02, signaling thta more than two weeks of buying pressure is needed for shorts to cover at current volume levels. Look for a possible squeeze catalyst in CarMax's third quarter earnings, set to hit Wall Street later this month.