Short sellers renew bets against Canadian banks in 2019 — so far they’re paying a high price

Short sellers have renewed their interest in Canadian banks in 2019, but so far the trade appears to have been a costly one. 

Short interest in the top eight Canadian banks increased by 16 per cent between Jan. 1 and Jan. 29, according Ihor Dusaniwsky of S3 Partners, a financial technology and analytics firm based in New York City.

In that time, short sellers increased their positions by more than US$1.5 billion.

Scotiabank and Royal Bank of Canada saw more than US$420 million in new short interest since the start of the year, while Toronto-Dominion Bank is the most shorted, with an outstanding short position of US$2.98 billion, according to figures provided by S3.

Overall, short interest in the big Canadian banks now stands at US$11.39 billion, above the level at which it last peaked in early December.

Between Dec. 1 and Jan. 1, total short interest in the banks fell to US$9.8 billion from US$11.17 billion. During that time, major North American indexes briefly entered bear market territory, and each of the eight banks hit 52-week lows.

S3’s figures suggest investors have reestablished those shorts even as bank stocks have surged to start 2019. As a result, according to Dusaniwsky, short sellers have lost more than US$1.13 billion on the banks alone in January.

Crescat Capital, a hedge fund based in Denver, Colo., is one of the firms “intensifying” its short position on Canadian banks, according to Tavi Costa, the company’s global market analyst. 

Costa admits it can be an expensive position — but is willing to take same pain in search of larger gains. Costa is predicting that a bursting credit bubble in China will trigger a global downturn. The effects will spill over into housing markets in Canada and Australia when those countries can no longer rely on capital inflows from China, he said.

We think the housing sector is the poster child for all the problems and imbalances we see in Canada today

Tavi Costa, Crescat global market analyst     

If the Canadian housing market crumbles, Costa said, the banks will be the ones “holding the bag.” 

“We think the housing sector is the poster child for all the problems and imbalances we see in Canada today,” Costa said. “It’s pretty clear to us that the financial sector … when the economic cycle turns, are the ones that take the most hits.”

Costa would not speak about individual names Crescat is shorting, offering only that the firm has positions in “all the big liquid ones.”

Costa is also concerned that, according to his figures, 80 per cent of Canada’s non-financial stocks are not cash flow positive. Those numbers are in stark contrast to the economy reaching full employment.

“How can you have such a strong and tight labour market at the same time that companies are not making any money?” he asked. 

Some analysts have also expressed concerns about the sector. On Monday, Bank of America analyst Ebrahim H. Poonawala downgraded BMO to underperform from neutral due to concerns over “revenue risk from slowing GDP growth,” according to Bloomberg.

How can you have such a strong and tight labour market at the same time that companies are not making any money?

Tavi Costa, Crescat global market analyst    

This follows Morningstar analyst Eric Compton downgrading both Scotiabank and BMO on valuation to three-star ratings — the equivalent of a “hold” rating, he said — from four-star earlier in the month. In BMO’s case, Compton said, the decision reflects the January share price bump which brought it closer to  his “fair value estimate.” 

Scotiabank is a different case, he said. Its strategy of expanding into emerging markets in Latin America and the acquisitions it has made since make it a riskier play, Compton said. While its rising stock price also had an impact on the grade, its emerging markets strategy — Scotiabank  worries Compton and thus entails requiring a “higher discount in general.”

Like Costa, Compton also worries about the housing market and its impact on the economy, calling it the “biggest risk to the banking sector in Canada.”

“Everyone’s walking on eggshells,” he said.

But unlike Costa, Compton subscribes to the “soft-landing” thesis, which suggests prices will drop as regulators step in to moderate the market. “That’s largely already started to happen,” he said.

“I don’t think it’s going to be a financial crisis like in the U.S.,” he added. “It’s going to lead to slowing growth, you’re going to get some losses, but it’s going to be manageable.”

Published at Mon, 04 Feb 2019 14:33:12 +0000