When Shorted Stocks Stand Tall

Markets had a pullback this week despite a concerted effort by retail investors on the subreddit “Wall Street Bets” to create a short squeeze in heavily shorted names. The highest 50 short interest names in the Russell 3000 have gone parabolic. The short covering, or buying of high short interest names, forced long short hedge funds to degross their balance sheets and deleverage their portfolios. So, in many cases, high short interest names closed the week up, while crowded longs closed lower. In general, despite the melt-up in heavily shorted stocks, the environment was very much risk off, and the S&P 500 closed down 3.5 percent for the week. The Dow Jones Industrial Average closed off 2.7 percent, and the Nasdaq 100 closed off 4.7 percent.

In some ways, retail forcing institutions to follow their lead is something of a new phenomenon. In others, we saw this kind of frothy market action in the late 1990s as retail investors chased stocks with no earnings, no cash flow, and questionable business models. It is particularly damning to the hedge fund community, which, given the 2/20 fees they charge, should have a sufficient handle on risk management to preclude being forced into liquidation by a bunch of millennials in a chat room.

Of course, no one really knows who is pulling the strings behind the scenes. In some ways, the traditional and social media narratives were a real “Occupy Wall Street” redux, pitting haves against have-nots. Pundits, politicians, and portfolio managers, in an effort to look like they were “doing something,” all contributed to the cacophony. This has served to entirely dominate the conversation, and earnings season completely overshadowed – despite having seen some very good quarters, broadly speaking.

Hard assets, broadly, were not immune to the risk-off environment. However, the Reddit crowd got hold of silver and some of the high short interest stocks in the precious metals realm. The iShares Silver Trust had a wild week, and closed up 4.8 percent. Gold had a decidedly more muted week, closing down 1.3 percent. One very heavily shorted silver stock closed the week up 28.2 percent. Precious metals miners, as represented by the GDX mining index, in aggregate, closed down 2.7 percent after a very volatile week. The GDXJ Junior Gold Mining Index closed off 1.1 percent. It is encouraging that junior gold stocks, which can be thought of as call options on gold in the ground to be produced at a future date, actually outperformed the yellow metal itself. Platinum was also challenged in this risk-off week, closing down 3.3 percent.

The risk-off environment was a particular challenge for natural resources more broadly. The S&P Global Natural Resources Index was off 4.5 percent for the week, and the NYSE Mkt Natural Resources Subsector was off 3.2 percent. Despite the short-covering rally, energy stocks were particularly challenged. The S&P Oil and Gas Exploration and Production Index was off 4.5 percent for the week, and the OIH Oil Services Index was off 3.8 percent for the week, despite the fact that WTI Crude was only down 13 basis points. That does not mean that there weren’t significant outliers. One heavily shorted offshore driller with a very challenged balance sheet and dim fundamental prospects closed the week up 27 percent. Natural gas had a challenged week, closing off 4.5 percent. Copper behaved in risk-off fashion as well, closing down 2.7 percent. It’s now down for the year. Iron ore was off 1 percent, zinc was off 4 percent, nickel off 1.4 percent. Lead was flat.

Defensive sectors held up better than most, and outperformed the broader market. The Dow Jones REIT Index was off 98 basis points, and the Dow Jones Utilities Index was off 1.7 percent. However, the US Infrastructure Index was off 5 percent for the week. The Alerian MLP Index was off 2.2 percent, outperforming infrastructure more broadly. That is very different than what we saw in 2020.

Periods of short covering, wild speculation, and liquidity-driven speculation are nothing new. Often it can be difficult to tune out the noise. For many, it can be tempting to try to trade on and capitalize on this kind of environment. However, this has a very dark side. As we have seen over and over again throughout history, the madness of crowds can often end badly as the markets and individual stocks revert to valuation and fundamentals. Caveat emptor.

Best Regards,

David McAlvany
Chief Executive Officer
MWM LLC