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A wild ride in U.S. stocks, stemming from betting tactics inspired on social-media channels like Reddit and Discord, may have exposed some longer term problems in strategies where investors bet on the decline in value of a company’s stock.
Such so-called short selling practices have been facing challenges ever since the economic recovery from the COVID-19 pandemic, beginning back in March last year, as the recovery has proved stronger and faster than many bearish bettors anticipated, according to Deutsche Bank’s strategists.
Citing his fellow DB analyst Binky Chadha, Jim Reid says that after a “remarkably consistent and successful 35-year track record of out-performance, short selling strategies were already under pressure before the reddit crowd took over and exaggerated it…”
A chart from DB shows that between 1985-2019, a basket of the most shorted stocks outperformed the Russell 3000 RUA, -0.01% by 6.9 percentage points.
However, that trend shifted in March, with Chadha speculating that “short exposure remained heavily concentrated in stocks with low profitability and growth, especially in pandemic-affected industries, even as the rapid and sharp economic recovery improved the prospects for these companies.”
via Deutsche Bank
“Indeed due to the unparalleled interventions, this was likely the shortest recession in history. This may have played havoc with this trade,” wrote Deutsche Bank.
Coronavirus aid checks, sent to Americans who had lost their jobs due to measures to limit the spread of the pandemic, also helped to amplify the moves, with individual investors plowing more money into the stock market and posing problems for short selling investors, including a number of hedge funds that have been hard hit by surge in the share prices of troubled business including GameStop, AMC Entertainment Holdings AMC, -12.48% and BlackBerry Ltd BB, -4.72%.
So far, the surge in stocks of those companies, propelled by individual investors targeting small, heavily shorted companies, has subsided somewhat, but it is unclear how this will impact the longer-term short selling strategy, Reid and his colleagues write.
GameStop, for instance, has been on a steady decline this week, down more than 20% but is still holding on to a 167% year-to-date gain. By comparison, the Dow Jones Industrial Average DJIA, -0.09% is up 0.6% this week and looking at a 2.3% in the first six weeks of 2021, while the S&P 500 index SPX, -0.13% is up 0.6% for the week and over 4% on the year so far.
According to short-interest data, GameStop remains one of the most heavily shorted stocks, with 121% of its oustanding shares being sold short, while AMC Entertainment has about 78% of its shares being shorted.
