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Pharmacyclics, Inc. (PCYC), Annaly Capital Management, Inc. (NLY): Shorts Are Piling Into These Stocks. Should You Be Worried?

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The best thing about the stock market is that you can make money in either direction. Historically, stock indexes have tended to trend up over the long term. But when you look at individual stocks, you’ll find plenty that lose money over the long haul. According to hedge fund institution Blackstar Funds, even with dividends included, between 1983 and 2006, 64% of stocks underperformed the Russell 3000, a broad-scope market index.

Pharmacyclics, Inc. (NASDAQ:PCYC)

A large influx of short-sellers shouldn’t be a condemning factor for any company, but it could be a red flag from traders that something may not be as cut-and-dried as it appears. Let’s look at three companies that have seen a rapid increase in the number of shares sold short and see whether traders are blowing smoke or if their worry has some merit.

Company Short Increase June 28 to July 15 Short Shares as a % of Float
VelocityShares Daily 2X VIX 234.6% N/A*
Johnson & Johnson (NYSE:JNJ) 26.9% 2.2%
ARMOUR Residential REIT, Inc. (NYSE:ARR)
60.8% 5.7%

Source: The Wall Street Journal. *ETNs do not have a fixed number of shares.

Worrisome worries
If, as an investor, you believe the market is headed lower, there are smart ways of betting in favor of downside action and investing methods you’d want to avoid at all costs. Purchasing the VelocityShares Daily 2X VIX — essentially an ETN that closely tracks twice the move of the volatility index known as the VIX — is the absolute wrong way to go about it.

Since early October 2011 when the stock market had its most recent sizable swoon and volatility spiked higher, the VelocityShares double-weighted VIX ETN has lost an astonishing 98.3% of its value. A lack of volatility, time decay, and daily rebalancing, has crushed this ETN built upon worry and volatility and reminded investors in very blunt fashion that double-weighted ETFs and ETNs are rarely, if ever, profitable ventures over the long-term and are better left untouched.

In this case, a huge rise in short interest in VelocityShares Daily 2X VIX is probably well deserved. There will undoubtedly be small rallies in this ETN when the markets head lower and uncertainty picks up. However, over the long run, the factors listed above will naturally take this ETN closer and closer to zero.

Quietly dominating
Many investors have grown quite skeptical of Johnson & Johnson’s nearly perfect ascent from $70 to $93 since the year began given its history of steady, but slow growth. At roughly 16 times forward earnings J&J may not be expensive relative to the S&P 500, but historically speaking it and its price-to-cash-flow ratio is higher than in recent years. But short-sellers are ignoring two key components to J&J’s business that I wouldn’t dare stand in the way of.

First, J&J purchased Synthes last June in a gigantic $19.7 billion deal that was targeted at boosting its orthopedic medical device market share — but more so to gain a foothold in emerging market regions where Synthes is rapidly growing sales. Even though J&J’s consumer products segment is growing at a snail’s pace, its orthopedics segment growth could really surprise Wall Street come earnings time.

The other factor that makes J&J a company I wouldn’t dare bet against is its top-notch pharmaceutical program. J&J has delivered incredible wins over the past couple of quarters including the approval of Invokana, the first SGLT-2 inhibitor approved in the U.S. to treat Type 2 diabetes, as well as its December 2011 licensing partnership with Pharmacyclics, Inc. (NASDAQ:PCYC) over experimental drug, ibrutinib, which has been designated as a breakthrough therapy by the Food and Drug Administration for the treatment of two rare blood cancers and could generate up to $5 billion in peak sales if approved (it’s currently under review by the FDA).

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