The S&P 500's 5 Most Hated Stocks

It has been an incredibly good year for the broad-based S&P 500 (^GSPC -0.88%) -- perhaps even too good depending on who you ask. The benchmark index is up a whopping 23.5% year to date, putting it well ahead of the average annual gain seen over the past century of about 8% to 10%.

Helping send the S&P 500 higher has been a number of positive economic reports that continue to fuel the hope of optimists that this rally isn't anywhere near over. Initial weekly jobless claims remains low, which has helped push the unemployment rate lower; housing prices are vaulting higher despite tepid mortgage originations growth thanks to tight housing inventory; and better-than-expected ISM and Chicago PMI readings would signify that the manufacturing sector is in better shape than anyone had predicted. On the surface, we have all the makings of a continuing recovery when coupled with ongoing easing from the Federal Reserve.

But as pessimists will tell you, looks can be deceiving. Beneath these strong economic results we also have a number of large companies needing to cut jobs and other expenses, as well as boost share repurchases just to deliver growth to their bottom line. This lack of organic growth could be a sign of weakness yet to come. In addition, pessimists point to the "X factor," which in this case is Congress, as a potential monkey wrench. Politicians' inability to solve to debt-ceiling crisis resulted in a 16-day government shutdown last month and could set the U.S. economy up for trouble come early February when a debt-ceiling solution needs to be announced.

That's why today, as we do every month, I'm suggesting we take a deeper dive into the S&P 500's five most hated stocks. Why you ask? Because this way we can better understand what characteristics, if any, attract short-sellers so that we can avoid buying similar companies in the future.

Here are the S&P 500's five most hated companies:

Source: S&P Capital IQ.

Cliffs Natural Resources
Why are investors shorting Cliffs Natural Resources?

• The primary reason pessimists have piled into Cliffs Natural Resources and once again pushed it to the top of the S&P 500's "short list" has to do with the miserable ongoing outlook for the mining sector. A two-year slowdown in China has reduced its need for many commodities, including both metals and energy assets, while iron ore prices (the primary revenue source for Cliffs) have been in the dumps for much of the past year. All told, Cliffs has needed to drastically reduce its capital expenditures and slash its dividend by roughly three-quarters just to remain profitable and conserve its cash flow.

Is this short interest warranted?

• While pessimism is certainly granted, given the projected downtrend in mining and the confirmation of that downtrend via three downward forecast-revisions by heavy-duty mining-equipment manufacturer Caterpillar this year, Cliffs' results are nowhere near so poor as its high level of short interest would lead you to initially believe. Cliffs' third-quarter results point to a company that enjoyed a 17% increase in iron ore prices for the quarter, coupled with an 11% decrease in expenses. With costs well under control, prices improving, and China perhaps on track to deliver sequential GDP growth once again, I'd say Cliffs has a better shot at drubbing short-sellers than helping them out.

U.S. Steel
Why are investors shorting U.S. Steel?

• Not to perform a rinse and repeat, but pessimists are betting against steelmaker U.S. Steel for many of the same reasons they're betting against Cliffs Natural: weak growth in China and depressed commodity prices, in this case for steel. U.S. Steel has been at a disadvantage to overseas manufacturers, which can undercut its prices, reducing its international sales potential and coercing it to reduce capacity in order to cut expenses. Having not produced a full-year profit since 2008, U.S. Steel is giving pessimists all the fuel they need for their fire.

Is this short interest warranted?

• Despite U.S. Steel's most recent earnings report signaling that the worst may indeed be in U.S. Steel's rearview mirror, I still have my doubts about the company's ability to outperform its peers given its monstrously high debt load. In that report U.S. Steel highlighted improvements in its flat-rolled steel operations but also pointed to ongoing weakness in the fourth quarter, as well as weak demand in Europe. With the company still reporting quarterly losses, I'm to the point where I'd strongly consider waiting on the sidelines, especially following U.S. Steel's huge run higher, for the company to report consecutive quarterly operational profits before even considering it a buy.

J.C. Penney
Why are investors shorting J.C. Penney?

• The question should be, "Has J.C. Penney given investors a reason not to be short at this point?" J.C. Penney has been a retail disaster that has reported six consecutive quarters of double-digit same-store sales declines coupled with massive losses that totaled close to $1 billion last year alone. As a true sign of desperate times, Penney's rehired the Mike Ullman, the CEO it sought to replace with the hiring of the former head of Apple's stores, Ron Johnson. With losses expected for as far as the investor can see, short-sellers are not counting on Penney's to survive much longer.

Is this short interest warranted?

• If J.C. Penney isn't the prototypical short that pessimists are looking for, then I'm not exactly sure what short-sellers are looking for in the first place. Penney's CEO, Mike Ullman, has stated publicly that Penney's same-store sales could turn positive after the third quarter, but I doubt that gets the company anywhere near profitability even with hefty cost cuts. The damage of its one-year "everyday price" experiment and store-within-a-store concept has been done, and it's pretty evident that few customers have come back. This company remains an "avoid" in my book.

Pitney Bowes
Why are investors shorting Pitney Bowes?

• Despite a moderate month-over-month reduction in short interest in Pitney Bowes, pessimism surrounding the logistics giant remains relatively unchanged. The case against the supplier of mail software and hardware solutions is that as mail becomes increasingly digitized, the volume of mail in this country will fall, hurting the need for, and the pricing of, Pitney Bowes' solutions. With revenue declining for four straight years (and growing) and the company slashing its dividend by 50% earlier this year, Pitney Bowes hasn't exactly delivered anything to make pessimists think otherwise.

Is this short interest warranted?

• But just when you thought Pitney Bowes was left for dead, it re-emerges in the third quarter with a market-topping adjusted earnings beat of $0.09 on the heels of aggressive price cutbacks. Before you get too excited, though, keep in mind that revenue again fell by 1%. Although Pitney Bowes bolstered its cash position by selling its management division in July for $400 million, which should allow it to continue paying out a handsome dividend, I still don't see how it corrects its declining revenue problem. Until we see concrete evidence of a push into the cloud and stabilizing revenue, I'd suggest that Pitney Bowes, too, remains off limits.

Frontier Communications
Why are investors shorting Frontier Communications?

• Unlike some of the aforementioned companies here, we're still patiently waiting to hear from Frontier Communications with regard to its third-quarter results. The case against Frontier has pretty much been the same for years: It went heavily into debt to purchase a boatload of rural landline assets from Verizon, which have thus far only seen a steady exodus of telephone subscribers as the scope of wireless coverage has improved to certain rural areas. The thought process here for short-sellers is that if Frontier were to cut its dividend, its share price would get hammered -- and many short-sellers expect that a dividend cut could be around the corner.

Is this short interest warranted?

• Another quarter, another $0.10 quarterly dividend declared for shareholders of Frontier this past Thursday. The company's still-steady dividend demonstrates that cash-flow generation remains strong despite what's expected to be another shrinking of its landline customer base. So long as Frontier can maintain a 9% yield, it will be painful for short-sellers to bet against this cash cow.