Citi is among the players facing pressure as the stock threatens to breach key support levels, while CIT Group has seen some 22 percent of its float in the hands of shortsellers, according to Reuters Specialist Editor Dan Burns.

Hedge fund stories from the past 24 hours from Reuters and elsewhere:

Chanos shorting AstraZeneca, Siemens - CNBC

Hedge funds seek closure of Venus Remedies - Economic Times

New Merk funds offer currency for all - Reuters

Hedgies profit from bank rally - MarketWatch

Tudor’s Hillery joins Brevan Howard - FT Alphaville

2008 may have been the year of shorting imperilled financials, but 2009 could be the year of shorting companies with too much debt or those bearing the brunt of the recession.

Numbers from Dataexplorers show Consumer Discretionary and Industrials are among the sectors with the most stock out on loan in the UK– a good indicator of short-selling activity.

Recent articles on Hedge Hub have shown that short-sellers have been setting their sights on stocks in both sectors, targeting those companies for whom the mountain of debt built up in the good times may prove too much, even with an easing of credit markets.

Alternatively, funds may be wary of companies very exposed to a prolonged economic downturn — retailers and manufacturing.

Information Technology is the UK sector with the most short interest, following a strong rally since March.

Meanwhile, there may yet be question markets over the huge rally in financial stocks — the sector has seen the biggest increase (18 percent) in short positions over the past week.

Sector                                           Pct of market cap on loan

Consumer Discretionary                             2.84

Consumer Staples                                     0.77

Energy                                                      0.47

Financials                                                 1.39

Healthcare                                                1.56

Industrials                                                 2.39

Information Technology                              2.89

Materials                                                  1.02

Telecom services                                       0.77

Utilities                                                    1.02

Source: Dataexplorers

(See also Indebted companies - long or short?, Not so good old Yellow Pages and Caught Short)

Hedge Hub readers shouldn’t have been too surprised by yesterday’s 15 percent slump in Yell’s share price.

The directories firm — the one behind the UK’s Yellow Pages — faces months of talks with banks and shareholders after yesterday saying it plans to restructure its roughly 4 billion-pound debt burden for the second time in nine months.

Yell has had to battle a slump in classified advertising spending and a shift to online from print publications, and analysts have been predicting it could breach its covenants as soon as the start of next year.

Our blog on June 23, citing research from Dataexplorers, showed that Yell Group is among the top ten non-financial firms with the biggest net debt to equity ratios out of the 300 largest listed companies in the UK.

We also showed that Yell ranked 1st in Dataexplorers’ Negative Sentiment indicator, which highlights where stock out on loan — usually used for shorting — has been highest and is rising.

Some fund managers have been buying, and making money out of, companies whose share prices were trashed last year because refinancing looked difficult, but where access to funds have recently become easier.

However, firms treading too close to the edge — carrying massive debt burdens while trading is rocky — could find it a different story.

The research also highlighted Debenhams as being in the top ten for net debt to equity and 4th on the negative sentiment score, as well as several companies in the U.S., Japan and Europe.

Which company is next in line for its share price to take a kicking because of its debt?

Convertible arbitrage is the hedge fund trade of the moment, with top-ranking returns of 12.58 percent so far this year, but there could be more to come.

The strategy, in which managers usually buy a convertible bond and short the underlying stock, is proving particularly profitable because the bonds are rebounding from the battering they took last year. The strategy lost 31.59 percent, the second-worst performing strategy, in 2008 as funds scrambled to sell their positions in what had become a crowded trade.

Such is the scale of the rebound in convertible bonds now that simply buying the convertible, without shorting the underlying stock, is proving very profitable.

Paul Compton, head of product management at software group Sungard’s alternatives business, thinks the outlook is positive.

“In 2008, valuations in the market were so depressed, not just due to credit spreads but also prime brokers withdrawing leverage. Investors got seriously cold feet and redeemed. More than half the convertibles universe was owned by convertible arbitrage funds and the market couldn’t really absorb that,” he said.

“My gut feeling is there’s more to come, now that the market is starting to behave a bit more normally. It could be the stand-out performer of 2009 because of the depressed state of valuations in December, although if there’s a stunning recovery in the stock market it will probably underperform.

“What is really needed is to lock in investors and not face redemptions. We’ve seen new funds launch and distressed credit funds getting into convertible arbitrage.”

David Einhorn again sent markets scurrying last week when he told investors he was shorting Moody’s Corp, but the Greenlight Capital manager’s latest thumbs down packed a weaker punch than his past, celebrated broadsides.

To be fair, Einhorn had a tough act to follow. A year ago, he boldly said Lehman Brothers was in much worse shape than its management would admit. Four months later — the bank went bankrupt and the shares were wiped out. It took more than six years, but his warnings about business lender Allied Capital also proved accurate and ultimately very profitable.

Last week, the soft-spoken Einhorn turned his sights on the parent of credit rating agency Moody’s Investors Service. Investors dutifully followed Einhorn’s lead and sent Moody’s shares down as much as 8 percent before they closed at $26.89.

Yet in the three trading days since, Moody’s stock has recovered its Einhorn losses and more. The shares traded at $28.66 a share Tuesday.

In a speech titled “The Curse of the AAA,” Einhorn said Moody’s credibility was wrecked after perfection-rated companies like AIG, bond insurer MBIA and Fannie Mae, not to mention the mortgage- backed securities market, all collapsed.

“Investors who bought AAA-rated structured products thought they were buying safety, but they instead bought disaster,” he said. “Investors have figured this out and many deny that they buy bonds based on rating, unless they are forced to by law.”

But that is hardly news to all the people who though Enron was a solid bet … until it went belly up. Einhorn told Reuters he has contemplated a ratings agency short since Pershing Square’s Bill Ackman publicly questioned the AAA rating of MBIA in 2002.

Einhorn declined to elaborate on the reasoning for his Moody’s short, though his speech indicates it boils down to a bet that the U.S. government changes the rules that created the Moody’s/Standard & Poor’s/Fitch Ratings oligopoly. He called on regulators to eliminate this system.

Compare that with his Lehman call, when Einhorn unleashed a barrage of details that showed Lehman’s financial statements were riddled with problems.

Einhorn, speaking last week to more than 1,000 hedge fund investors at the annual Ira Sohn Investment Research Conference, observed that Lehman made investors dig through tables and footnotes to find its exposure to CDOs – mortgage-related assets that had been the subject of scrutiny for months.

When the bank actually took write downs, he showed they were low-balled. He blew the whistle on a $1.1 billion discrepancy — positive to Lehman — between Level 3 assets in its 10-Q filing and former CFO Erin Callan’s description of them in a conference call with analysts.

He raised red flags when the bank booked a more than $400 million gain for a nonexistent round of capital raising and when it did not mark down Suncal, a large California land developer slammed by the housing slump.

Yes, Moody’s trades at a healthy 19 times earnings, but the stock is already down 61 percent from its 2007 peak — a fall twice as hard as the S&P 500 index.

So, David, we see the smoke, but where’s the fire?

(Einhorn, in an e-mail response, observed that short term stock movements are not the best barometer of the quality of an investment call. Lehman shares rose on the morning of November 28, 2007, the first time he spoke about his negative views on the bank, and continued to climb for months thereafter. Allied Capital, of course, saw its shares climb for five years before the credit crunch exposed its weaknesses in latye 2007.)

Plenty has happened since the UK brought in its temporary ban on short-selling financial stocks last year — Madoff, Weavering, hedge fund outflows, the EC’s controversial plans for hedge fund rules, and even a few hedge funds making money.

However, behind the scenes, the debate on how to handle this controversial practice rumbles on, and today the Investment Management Association published its response to the FSA’s discussion paper, now that the period for responses has closed.

Much of it is as expected — a strong defence of short selling, highlighting its role in investment management, risk management, providing liquidity, cutting transaction costs and helping to ensure price efficiency — but there are some points to pick out.

For instance, the IMA believes no justification for banning naked short selling — a particularly controversial practice whereby someone shorts a stock without first borrowing it or ensuring they can borrow it – has yet been made, pointing out that the level of failed trades on the London Stock Exchange is very low, “with few of those that do occur being identifiably linked to naked shorting”.

It also puts forward a forceful argument on transparency, arguing disclosure to regulators is “an important check on the markets” but that wider disclosure to the market could cause problems.

“Firms which do this work (research on shorting a stock) should not have their valuable conclusions given away free to others,” says the IMA, arguing short sellers are less likely to put in the work, meaning liquidity is reduced, pricing will be less accurate and “bubbles will continue for longer than they would otherwise”.

“I am … most disappointed that there is no real discussion of the benefits or costs of market transparency in this paper, which, in my view, fatally undercuts the arguments put forward in favour of transparency,” says IMA regulatory adviser Adrian Hood.

Meanwhile, those who do put on short positions that are then disclosed could see ”free-riders” pile in afterwards, the IMA says, pushing down the stock’s value and increasing volatility.

The debate about whether or not short selling was driving down some banks’ share prices erupted last year at the nadir of the financial crisis. Ironically, if the optimism of the past two months, and the predictions of a possible new bull market by Crispin Odey and Anthony Bolton, are correct, it may no longer be such a controversial issue by the time the FSA draws its conclusions.