The U.S. market has rallied over the last month with the S&P 500 up +5.6%, the Nasdaq up +9.8% and the Russell 3000 up +6.7%. Total domestic equity short interest has fallen in response to this broad rally by -$10.27 billion. But has this been a short squeeze, or just the normal ebb and flow of short selling and reallocation that we normally see in the market?
The -$10.27 billion decrease in short selling, just a -1.25% decline, lowers total short interest down to $814.77 billion. This is a relatively small decline relative to the strong move in the markets over the last month. And if we remove the ten stocks with the largest amount of short covering over the last month the overall market decline is only -$812 million, a meager -0.10% drop.
In fact, increased short interest during market upswings is a normal occurrence. From January 1st, 2019 to the recent short interest high on January 22nd, 2020 the Russell 3000 rose by +17% while domestic short interest increased by over 33%. Although there were interim periods of short interest declines throughout the year, short interest increased for the year.
Why did this month’s rally not spur a market-wide short squeeze? The answer lies in the two underlying reasons for short squeezes: large mark-to-market losses and\or expensive stock borrow\financing costs which force short sellers to close out their positions. Shorts are forced to buy-to-cover if their mark-to-market losses exceed risk\loss limits or if the cost to borrow increases to the point of taking too large a bite out of expected Alpha.
Average market-wide stock borrow costs have not increased this year with the present average domestic cost to borrow at 0.75%, which is slightly less than 2019’s 0.77% average. On the Profit\Loss side, domestic shorts in the aggregate are up +$94 billion, +11.20%, in mark-to-market profits for the year. So, with market-wide stock borrow costs cheaper year-on-year and most short sellers profitable for the year, the chances of a market-wide short squeeze are minimal.
While there is no rationale for a market-wide short squeeze there are individual candidates for short squeezes. Individual stocks with large mark-to-market losses and\or high stock borrow fees are still prime candidates for short squeezes
Domestic Stocks with the highest Stock Borrow Fees ($100MM minimum short interest):
Large mark-to-market losses usually force short sellers to close out their positions quicker than high stock borrow fees. There are individual stocks that have incurred large 30 day mark-to-market losses and overall year-to-date mark-to-market losses. But overall, short sellers are up $94 billion, +11.20%, for the year, even after being down -$79 billion, -10.06%, over the last 30 days. Year-to-date winners on the short side outnumber losers by 2.4 to 1.
Domestic Stocks with the largest 30 day mark-to-market losses ($100MM minimum short interest):
While we do not see a market-wide short squeeze taking place in the near future to turbo-charge the stock market, there are several stocks which are prime short squeeze targets.
Co-Diagnostics Inc (CODX) is the most expensive short in our league table and has year-to-date mark-to-market losses. If CODX continues to rally we should see some shorts getting squeezed out of their positions.
The high stock borrow fee cannabis stocks on our list are not short squeeze candidates as Tilray (TLRY), Aurora Cannabis (ACB), Aphria (APHA) and Cannabis Growth (CGC) are all profitable for the year, including their high stock borrow costs.
SmileDirectClub (SDC),Hertz (HTZ), Gamestop (GME), Nordic American Tanker (NAT), Clovis Oncology (CLVS), Revolve Group (RVLV) and American Airlines (AAL) are also high stock borrow cost stocks but net winners on the short side so are also not short squeeze candidates.
Virgin Galactic Holdings (SPCE) shorts are down for the year, with a third of their -$102 million in net losses, -31%, are due to high stock borrow fees. SPCE is a prime example of a short squeeze candidate due to both high financing costs and mark-to-market losses.
Mallinkrodt PLC (MNK) shorts were only down -$300 thousand in mark-to-market losses for the year, but shorts incurred -$23 million in stock borrow costs. If shorts feel their expected Alpha is not going to be generated in a timely manner, the high stock borrow costs may push some shorts out of their positions. Shorts will stay in stocks with high borrow fees and high mark-to-market profits but paying hefty fees to lose money is a sure recipe for a short squeeze.
GTT Communications (GTT) shorts are up +$20 million in mark-to-market profits in 2020, unfortunately they have paid -$28 million of stock borrow costs to make that +$20 million. When financing expenses outweigh trading profits short sellers usually exit their positions. Unfortunately, many traders\investors do not pair their financing costs and trading results on a ticker by ticker basis because their systems only report financing costs on an account level. Those that can see their net P\L, by using our Blacklight SaaS platform for example, will be squeezed out of the trade. Those that do not look at their net-of-financing P\L may stay in their trades and bleed losses for a while longer.
Bill.com Holdings (BILL) and Inovio Pharma (INO) are both down large in mark-to-market losses, down -$172 million and -$208 million respectively, and their high stock borrow costs make them strong candidates for a short squeeze.
Stocks with large percentage losses relative to their short interest are also prime short squeeze candidates regardless of their cheap financing costs. Stocks such as Twilio (TWLO) -86%, Wayfair (W) -89%, Sea Ltd (SE) -80%, Coupa Software (COUP) -59%, Pinduoduo (PDD) -82%, MongoDB (MDB) -61%, Shopify (SHOP) -104%, Eldorado resorts (ERI) -66% and Chegg (CHGG) -61% may see shorts lose their conviction in the face of large red numbers in their portfolios and begin to cut their positions.
Tesla (TSLA) is down over -$10 billion in mark-to-market losses, -79%, for the year but is a horse of a different color than run of the mill shorts. With a large portion of its short interest tied up in a convertible arbitrage trade and another large portion of its short tied up in the portfolios of steadfast, almost cultish, short sellers the chance of a short squeeze is minimal. There is a portion of its shorts which are more short term and will exit their positions if their losses mount, but most of those have already been shaken out their trades.
While we should not have a market-wide short squeeze in the short term, if the markets continue to rally and mark-to-market profits continue to be eroded there will be more and more individual stocks that will fall into the short squeeze bucket. Stocks whose stock borrow rates and stock prices spike, will join the ranks of Virgin Galactic, Twilio and Wayfair as short squeeze candidates that can boost stock prices with a surge of buy-to-covers.
Looking at short selling trends over time provides insight into overall market sentiment as well as the strength of bearish conviction in individual equities. Our Blacklight SaaS platform and Black APP provides an up to date view of short selling and short covering on an equity, sector, index, or country-wide basis allowing investors\traders to better manage their existing long and short positions.
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The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC (“S3 Partners”) to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks, and merits, as well as the legal, tax, accounting, and investment consequences, of such decisions.
