The S&P 500's 5 Most Hated Stocks

The broad-based S&P 500 (SNPINDEX: ^GSPC  ) may be on its longest losing streak in more than a month -- a mere four days -- but you may not even have noticed, given that the index is up a whopping 26% year to date. With a gain like this, the iconic index is on pace for one of its best years on record.

Strong economic data has been the name of the game throughout much of the year, with the unemployment rate dipping to a six-year low and yesterday's ADP employment report confirming the jobs market's strength with a higher-than-expected 215,000 private-sector jobs created in November. U.S. GDP growth has also been stronger than anticipated, and, thankfully, investors have enjoyed an ongoing monetary-stimulus program known as QE3 by the Federal Reserve throughout this process.

That could be about to change, though, as skeptics and pessimists are becoming worried about this rally. Front and center is the imminent end to the Federal Reserve's monetary-easing policy, which could mean a rise in lending rates and a load of negative consequences for the homebuilding and banking sectors. In addition, skeptics like myself have pointed to the fact that while EPS growth has driven this rally, most earnings growth is being achieved through share buybacks and cost-cutting, rather than organic sales growth.

With that in mind, I suggest we do what we do every month: 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:

Company

Short Interest as a % of Outstanding Shares

Cliffs Natural Resources (NYSE: CLF  )

29.22%

U.S. Steel (NYSE: X  )

24.75%

Frontier Communications (NASDAQ: FTR  )

19.87%

Lennar (NYSE: LEN  )

19.43%

Pitney Bowes

19.03%

Source: S&P Capital IQ.

Cliffs Natural Resources
Why are investors shorting Cliffs Natural Resources?

  • The case against Cliffs Natural Resources, an iron ore and metallurgical coal producer, hasn't changed in months. Short-sellers have piled into the company with the expectation that iron ore prices and demand will remain weak and that Cliffs will have no choice but to pare down its operations in order to save cash and maintain profitability. Earlier this year this short position worked wonders, with Cliffs slashing its dividend by 76% and iron ore prices caving. However, iron ore prices have staged a strong second-half comeback.

Is this short interest warranted?

  • As in previous months, I would suggest that there's greater potential upside in the shares than downside at current levels. Cliffs isn't without its ongoing struggles, as evidenced by its announcement two weeks ago that it would suspend its chromite project in Ontario, Canada -- where it has already sunk about $500 million -- until a few uncertainties clear up. However, a rebound in iron ore prices, surprisingly strong domestic and overseas demand for iron ore, and a stabilization in met-coal prices lead me to believe that investors aren't giving Cliffs nearly enough credit.

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

  • The case against steelmaker U.S. Steel is similar to the one against Cliffs, and it relates to the stock's recent rally. Steel prices have stabilized, and demand in China looks to be picking up once again right alongside stabilizing domestic demand, helping the bottom lines of most steel companies. U.S. Steel, though, reported a whopping $12.38 GAAP EPS loss due to huge writedowns in the third quarter, emboldening pessimists who believe it may be the worst in the steel sector. 

Is this short interest warranted?

  • I've been a pretty staunch supporter of U.S. Steel short-sellers throughout the past few months, and I'm going to continue lending my support until I see the company turn an annual profit led by organic growth instead of steep cost cuts. Even as it tries to stem its losses, U.S. Steel sports a somewhat worrisome $3.24 billion in net debt. This large debt load makes strategic moves difficult for U.S. Steel, and simply shutting down capacity only hurts its ability to drive organic growth. My suggestion continues to be that steel does make for an attractive long-term asset -- but I'd look elsewhere within the sector.

Frontier Communications
Why are investors shorting Frontier Communications?

  • Short-sellers have been relentlessly attacking Frontier since it went forward with its massive $8.5 billion purchase of Verizon's rural landline assets in 14 states three years ago. The deal was expected to allow Frontier to build out its enterprise service segment while also delivering steady cash flow from rural customers who lack access to wireless services. However, since the deal, Frontier has regularly lost landline subscribers, and twice lowered its dividend payout -- the primary investment driver in the stock.

Is this short interest warranted?

  • While I can definitely see why investors have little faith in Frontier's ability to grow, the residual cash flow created by Frontier's landline business and slowly growing broadband and enterprise service business continues to fuel its healthy dividend, which is currently yielding 8.5%. As a short-seller, that 8.5% yield would be enough to chase me away unless I saw a steep drop-off in landline subscribers or a dramatic increase in churn rate. With neither of those things happening now, I'd side more with a slow but steady rebound in Frontier shares from here.

Source: Great Valley Center, Flickr.

Lennar
Why are investors shorting Lennar?

  • The homebuilder with the highest homebuilding margins is suddenly the fourth-most shorted stock of the bunch. On the surface that would make little sense, but given that mortgage loan originations are down about 60% from their highs and spoiled consumers continue to sit on their hands instead of purchasing new homes because interest rates rose about 75 basis points from their record lows in May, it makes total sense. The thought here is that once QE3 ends, lending rates could rise and cripple the homebuilding sector no matter how tightly inventory is controlled.

Is this short interest warranted?

  • The homebuilding sector is one of three investments I listed earlier this week that I will not be buying in 2014, so I'd absolutely agree that the short-sellers could be on to something. I do consider Lennar to be among the best in the homebuilding sector when it comes to margins, liquidity, and top talent among management. Ultimately, though, it's all about interest rates, and consumers just aren't biting at current levels despite the fact that rates are still historically low.

Pitney Bowes
Why are investors shorting Pitney Bowes?

  • Although Pitney Bowes is the fifth-most short-sold company within the S&P 500, you'll notice that the percentage of shares held short has dropped dramatically from the previous month as the recent rally sent some pessimists running with their tails tucked between their legs. The reason for the ongoing bearishness surrounding the mail logistics company is a multiyear revenue downtrend precipitated by a decline in the need for physical mail. With the USPS struggling and Pitney Bowes having slashed its dividend in half earlier this year, short-sellers are counting on continued top-line weakness from the company.

Is this short interest warranted?

  • Pitney Bowes has definitely made decisive moves to perk up its business and focus on its core strengths by selling both its furniture business in Norway and its North American management service business, but it really hasn't made great strides in stemming its top-line growth problem. Pitney Bowes has talked about its move into the cloud, but I've yet to see anything exciting materialize. Unless Pitney Bowes can stem its revenue slide, I believe short-sellers will eventually regain the upper hand.

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