It will likely take a steady stream of excited buyers to keep the GameStop, AMC rally going


Traders work on the trading floor of the New York Stock Exchange.


The lively, popular story in the markets last week showed the mass of retail investors taking off the bullies on Wall Street. The frenzied buying of sharply shortened discarded stocks caused complacent hedge fund managers who wagered bearish bets to take massive losses to abuse GameStop and AMC Entertainment.

As far as it goes, this is true – but it only goes so far as to cover maybe a few dozen stocks with extremely high short interest, and that doesn’t mean the broad market is ripe for these short squeeze stampedes are strong or a permanent driver of investment prospects.

In the simple David versus Goliath corner, some faulty premises are at work. For one thing, neither hedge funds nor short sellers have ruled the Wall Street playground in any way in recent years. On the contrary.

And the current market has an unusually low short base relative to total market value, which means less, if anything, a cushion of ingrained bear markets to add to index gains from here.

According to BarclayHedge, the annual return for long-short hedge funds has been between minus 3% and 9% over the past five years. Over the same period, the S&P 500 achieved an annual return of 15%. If hedge funds were market bullies who could get by with stocks they pile into, why would they limit themselves to such meager rewards?

While academic research has shown that sharply shortened stocks underperform long-term, this factor is not consistent across time periods. JP Morgan strategists showed last week that stocks with overcrowded short positions have performed roughly in line with the market as a group in recent years, before outperforming sharply in recent months when the “squeeze” Event “got rolling.

Selling short is expensive and risky because it is often costly to borrow stocks, losses are theoretically unlimited because stocks can go up indefinitely, and the predominant incentive for executives, analysts, bankers and long-term investors is to keep stock prices up float.

This is not to beg for sympathy for the poor short seller or to deny that shorts played their hand in targeting the stock group now based on social media-encouraged shortages. Just note that these were never omnipotent predators who could benefit from self-fulfilling short bets.

Indeed, the day-long surge in stocks, and particularly the call options of the handful of preferred stocks returning from the dead, begs the question of whether the squashers might be overdoing their hand right now.

Constant flow of buyers required

This data from Barclays shows the steep surge in option buying among short squeeze names this year, including and excluding GameStop, the squeeziest of squeeze stocks.

The massive exposure to these stocks through retail account options forced Robinhood and other brokerage firms to restrict trading in some tickers as the cost of collateral in the clearing and settlement process, which is two days later, is high when a trade is made .

Since these stocks have risen tremendously in the past few days and the volume is huge, it will likely require a constant stream of excited buyers to support these stocks.

As an example of rising stakes, AMC shares rose from just over $ 5 at the close of trading on Tuesday and ended at $ 13.26 on Friday. However, the average price all investors paid for the stock over those three days was over $ 14, given the amount of time the stocks spent between $ 13 and $ 16. A huge stock, but with young investors underwater, and in this case a company that has repeatedly issued new shares to bolster its balance sheet.

Even after the bears’ bloodshed, there remains significant brief interest in many of these names. While official data is only available every two weeks and with a delay, the short sale analysis company S3 Partners calculated on Friday that well over 50 million shares of GameStop were empty by Thursday – after around 70 million two weeks ago, but still strongly bearish Position.

(Note that the GameStop short position has routinely been described as well in excess of the total stock float. This is never the case: when a stock is sold short, a new long position is created and added to the float The same stock effectively belongs to the original owner and whoever bought it from the short seller who borrowed it.)

Broader market contagion?

In those names, the bruises may have more to do with. This has to remain a fairly localized issue, however, as the extent of short exposure in the market relative to total stock market value is at a 12-year low.

Certainly the losses of the entire dollar absorbed on the short side of the market are not trivial in the short term. Data analytics firm Ortex calculates its net loss this month to exceed $ 50 billion – a large part of the long-short investment cohort.

And the losses, along with the searing volatility from relentless pressure to buy destabilized portfolios, are enough to sell overcrowded long positions, a factor clearly part of the 3.3% decline in the S&P 500 last week drives. Piper Sandler’s Richard Repetto notes that the group of Wild Squeeze stocks “represents 4.6% to 7.6% of total consolidated US stock volume, compared to just ~ 0.5% of the volume that the group owns before the Reddit hysteria included. ” And the intraday volatility of these names over the past five trading days “averaged 72.2% compared to 1.5% on the S&P 500”.

Barclays strategist Maneesh Deshpande says: “The key question is whether the stresses from the brief press cause wider contagion as the shorts are forced to release the lever. The bottom line is that the pain could last for a short time full-fledged contagion remains low. “

The total market capitalization of stocks with a short-to-float ratio of over 20% is only about $ 40 billion. That’s one-tenth of 1% of total US market cap, which is approaching $ 40 trillion.

And if the squeeze-and-chase game continued until the shorts left the playground, it would lead to a market with even less short pillows, which is a headwind for stocks from a contrary perspective.

We’re not there yet. And the current 4% decline could certainly simply be a necessary adjustment in an overly long, overpopular market that was up 18% in about ten weeks.

But an exhausted short base is another unexpected factor to think about, along with a new market rhythm – no longer the prevailing band with passive index and quantum algorithm in recent years, and a more emotional, energetic, undisciplined and populist flow of legions smaller French fries.