As markets retreat, short-sellers are piling in

The number of shares short on the New York Stock Exchange has increased 50 percent from a year ago, and some Minnesota stocks are being caught up in the move.

The most recent report from the NYSE showed that the short interest had increased to nearly 15 billion shares, or 4.0 percent of total shares outstanding as of Feb. 29. Chuck Zender, co-manager of the local Grizzly Short Fund, has an answer to the rise in bets that shares will fall.

"There are two things. One, first of all, you are in a bear market. Secondly, the number of hedge funds and the amount of money managed by hedge funds has been proliferating, so there are more shares short for that reason. Those two things ... make for a pretty high number of shares short," Zender said.

The NYSE puts out a short-interest report twice a month. From February 2007 to February 2008, short interest increased by 49.8 percent. In 2007, short interest averaged 11.6 billion shares, or 2.8 percent of shares outstanding.

At its most basic, short-sellers make money by betting that a stock will go down. The way it works is, if you wanted to short 100 shares of a company, you or your broker would borrow the shares from someone and then immediately sell the stock. If the shares lose value, you "cover'' your short position by buying 100 shares at the lower market price and returning them to the lender.

Short funds such as the Grizzly might employ a number of related strategies. That might mean playing one company off its competitor, or a group of companies against the industry, or by investing in other vehicles such as corporate bonds.

Different from shares short is the short-interest ratio.

"The industry measures the short ratio as more important than the short as a percentage of shares outstanding," Zender said. The short-interest ratio is the short interest divided by the average trading volume over a certain period, usually 30 days. Sometimes referred to as "days to cover," it's the number of days it would take for the market to absorb or to cover the short position. Some investors feel that, the higher the short-interest ratio, the more upward pressure on the company's stock price.

As the price rises, short-sellers are under pressure to buy shares to cover their positions, further fueling the upward trend.

That phenomenon may have played out last week, when ValueVision rose 57 percent Thursday on heavy volume but little news. The average volume at ValueVision the previous 15 days was less than half a million shares, but volume jumped to 6 million shares Thursday.

But the theory that a heavily shorted stock is the proverbial coiled spring ready to pop is not absolute. Short-sellers can sometimes be as patient with rising prices as regular investors faced with declining prices.

If the Grizzly Short Fund is any indication, short-sellers should be doing well (aside from the 420-point jump in the Dow on Tuesday). So far this year, the Grizzly fund is up 23 percent. Zender doesn't comment about individual stocks, but the following Minnesota companies have generated a lot of interest from other short-sellers.

• Polaris: The company expects the tough external pressures it faced in 2007 to continue next year.

• Life Time Fitness: Membership growth has slowed, and costs to attract new members have risen.

• ValueVision: Authorized a $10 million stock repurchase program March 6, and earlier hired management consultants to conduct a business review. Shorts may be getting squeezed, as ValueVision rose 57 percent Thursday.

• MoneyGram: Shorts have an easy cover here; the stock was down 89 percent in 2008, and fell 17.5 percent more Tuesday, when the company was dropped from the S&P 400 MidCap Index.

• Fair Isaac: Some have questioned the effectiveness of the company's FICO credit score.

• Allete: Its small real estate business dragged down fourth-quarter profit. The company's guidance for 2008 was $2.70 to $2.90 per share, compared with analysts' consensus estimate of $2.80.

• Imation: Its stock price is flat this year, but well off a 52-week high of $41.92 in April.

• H.B. Fuller: Two analysts recently downgraded their ratings on Fuller, citing slowing growth and rising energy costs that directly affect chemical companies.

• Deluxe: The company still is working to diversify beyond printing checks.