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Nov 23, 2016

S3 BLACKLIGHT: Short Sellers Absent From Dryships Rally

The Dry Bulk Shipping Sector has had a volatile ride since the presidential election on November 8th. We’ll be looking at data for six companies in the sector with market caps under $100 million.
We are in the tail end of a downward trend in the cyclical shipping market after enjoying years of increases in dry bulk shipping rates due to China’s unyielding demand for commodities. A temporary shipping shortage enticed carriers to leverage their balance sheets and increase their shipping capacity by adding more tonnage to their fleets. As worldwide commodity demand waned, as reflected in a drop in the Baltic Dry Index, shipping rates came crashing down and the excess capacity has become an anchor for many of the shipper’s bottom lines.
A recent uptick in the Baltic Dry Index spurred investors and a mini rally occurred – followed by a momentum based spiral of buying activity which spiked some stock prices, notably Dryships (DRYS US) which climbed over 1500% in less than a week, into the stratosphere at supersonic speeds. Trading in Dryships was halted on several trading days because of bid-offer imbalances, more than a 20 fold price increase and an extreme increase in daily trading volumes which worried regulators that these irregularities might be due to market manipulation.
The average positive return of these six stocks was 568% from November 8th to 16th. But traders needed to be agile in order to keep their profits as two thirds of that price increase was given back by November 22nd. The rally and subsequent price reversal of these stocks was due to intra-day momentum trading bidding up six relatively illiquid stocks and eventually watching them free fall as buy side demand evaporated and most of the long stock holders rushed for the exits en masse. Daily trading volume for all six stocks which was just over $500,000 on November 8th nearly hit $1 billion on November 15th as traders bid up stock to get in on the action. In fact, the daily notional traded from November 15th through 21st was greater than the market caps of the six stocks. As stock prices dropped quickly in the week afterwards, trading volume was still high but started to decline as traders were more interested in exiting their positions rather than intra-day trading.
Although “Short Squeeze” was a popular explanation for the price volatility in these six stocks that was not the case. These stocks had small market caps and therefore relatively small stock lending pools to begin with. Short interest on November 8th was less than $2 million in total for all six stocks and actually grew to $23 million by November 16th at the height of the rally. Even if every single short seller was “squeezed” out of his position on the 16th, it would not have put a dent in the over half a billion in trading that occurred that day.
At times, the market blames the shorts for a stock’s price plunge, but in this instance the market should be lamenting the lack of short selling as stock prices soared. Because shorts could not participate in this tulip-like rally due to lack of stock borrow supply, there was no offsetting selling activity which would have acted as a release valve to the wave after wave of buyers bidding up these stocks’ prices. Short sellers would have seen the excessive upwards price moves due to this over-bought situation and sold into the rally, forcing either a temporary plateau which would have cooled off overheated buyers or several down ticks which would have scared speculators into thinking the “easy” trade was over. The lack of shorting caused this to be a one-way market which led to price spikes and subsequent sudden and painful price reversals.
Although there is a basis for the Dry Bulk Shipping Sector to see positive returns in light of an increase in the Baltic Dry Index, the recent rally created an over-bought situation. With short sellers not participating in these names in size it will be the short term long shareholders who will start selling their stock to try to capture and realize their recent outsized returns. When stock prices start moving lower, a reverse price spiral will appear as more speculators will be rushing for the exits. Much of that price drop has already occurred this week but the average stock price of these six stocks is still up 63% from their November 8th levels. There may still be a bit more of a correction coming, even if short sellers are forced to sit on the sidelines.
For more information on the above analysis, please contact:
Ihor Dusaniwsky, Head of Research, S3 Partners, LLC Ihor.Dusaniwsky@S3Partners.net

The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC ('S3 Partners') to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks and merits, as well as the legal, tax, accounting and investment consequences, of such decision.

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