We extract the news component of short-selling activity by accounting for important cross-sectional, distributional differences in short interest data. The resulting measure of surprise in short interest negatively predicts the cross section of both U.S. and international equity returns. Our results also indicate that this predictability originates from short sellers’ informed trading on mispricing and investors’ underreaction due to their anchoring on past short interest. Finally, consistent with the notion of costly arbitrage, the return predictability is stronger among illiquid, volatile stocks and stocks with high information uncertainty, but importantly, unrelated to short-selling frictions.