Photographer: Ian Waldie/Bloomberg

How to Trade Australia's Earnings Season: Buy the Shorted Stocks

  • Deutsche Bank analysis shows most shorted shares outperform
  • Study shows best to sell after results as performance fades

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With less than one week to go until the earnings season begins Down Under, it may pay to look now at those stocks with the largest bearish wagers against them.

That’s the conclusion reached by Deutsche Bank AG strategists whose data showed that the top ten percent of most heavily shorted stocks in Australia beat the market’s return some 80 percent of the time during results season. That outperformance typically disappears in the subsequent two months, according to the analysis.

“The most shorted stocks are good to own during results, particularly if there is conviction that earnings won’t disappoint,” Tim Baker and David Jennings, Sydney-based strategists at the German bank, said in a July 24 report. “But it’s worth selling after results.”

Deutsche sees large short positions making those companies ripe for a short squeeze, a situation forcing the bears to quickly reduce their positions. Here’s a list of stocks the analysts include in their most-shorted group for which their colleagues have buy ratings: 

  • Harvey Norman Holdings Ltd. and Automotive Holdings Group in discretionary retail
  • TPG Telecom Ltd.
  • Orocobre Ltd., Syrah Resources Ltd. and Independence Group NL in resources

It’s been a torrid time for Australian equities, which is among the worst performing developed markets this year. The S&P/ASX 200 Index is up just 1.1 percent in 2017, compared with a 12 percent gain on the MSCI World Index of global shares. Short sellers have flocked to consumer stocks with sentiment remaining in the doldrums as heavily indebted households struggle with stagnant wages.

The Deutsche Bank analysis during reporting seasons over seven years showed the most shorted group outperformed the market on average by two percent. If the stocks met analysts expectations, they would outperform by five percent, according to Baker and Jennings’ findings. 

“Avoiding the most heavily shorted companies during reporting season can be costly, especially if shorts are squeezed," they said. “At the sector level, the most heavily shorted sectors going into reporting season include discretionary retail, telcos and food and beverages.”

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