Bears, beware: The short squeeze is officially on.
The obvious canary in the coal mine here is Tesla Motors (NASDAQ:TSLA), the electric car manufacturer that the bears love to hate. Thanks to strong numbers and improving sentiment, short sellers have been stampeding for the exit — and the stock has doubled in the past 30 days.
It’s no wonder, with some 44% of TSLA float (that is, publicly tradable shares when you back out restricted stock) held by short-sellers as of April 30. Nobody wants to be the last to buy back shares and cover their trade — so the rush to buy after you’ve sold short results in a classic “short squeeze” that drives up prices dramatically.
Some of the S&P’s most hated (and heavily shorted) stocks have soared in the past few weeks thanks to similar conditions.
Take also brick-and-mortar bookseller Barnes & Noble (NYSE:BKS), with more than 30% of the float held short and 19% gains in the last 30 days — even after the rout yesterday on news that Microsoft (NASDAQ:MSFT) isn’t as set on a Nook deal as some rumors indicated.
Here are some others of note:
- 3D Systems (NYSE:DDD), a red-hot momentum stock in the emergent 3D printing business, had more than 30% of its float held short as of April 30. It is up 33% in the past 30 days.
- Supervalu (NYSE:SVU), a grocery store chain, had nearly a third of its float held short at the end of April. SVU is up about 28% in the past 30 days.
- Video game retailer GameStop (NYSE:GME) had 46% of its float held short on 4/30. It’s up 20% in the past month.
- Electronics retailer RadioShack (NYSE:RSH) had 41% of its float short as of 4/30. It is up 16% in the past month.
- Streaming video giant Netflix (NASDAQ:NFLX) had about 25% of its float short on 4/30. It is up 32% in the past month.
The craziest pick of all? For-profit education stock ITT Educational Services (NYSE:ESI) had a whopping 94% of its shares held short (at least according to the data on this Yahoo! Finance page)! That could be an error, but with only 23 million total shares outstanding and only 14 million or so actively traded as the float, it’s not unrealistic. Consider that right now, BlackBerry (NASDAQ:BBRY) has more than 150 million shares held short — but because it has more stock available, it’s a much lower percentage.
Needless to say the race for the exit in ITT can quickly turn into a stampede with that kind of crowded short — and it has, judging by the 50% gain in the past 30 days for ESI.
The list goes on. But the million-dollar question, of course, is whether this is good or bad for the market and for investors.
On the plus side, scaring out the shorts and providing upside for even battered stocks is a very good thing for sentiment. On a basic level, when stocks go up, it’s good for investors.
On the downside, however, it’s hard to imagine these gains sticking if they are based on a short squeeze. Just because the bears are capitulating doesn’t mean the bulls are willing to bid the stock higher … or that gains will stick.
A perfect example is Sears Holdings (NASDAQ:SHLD), which nearly tripled from under $30 at the end of 2011 to over $80 in early 2012 on a short squeeze. By the end of 2012, however, it crashed back to $40 again.
Short squeezes are great if you are on the right side of the trade and can capitalize on overly bearish investors getting burned. But don’t fool yourself and think that when Wall Street bails on a downside bet, it is a guarantee for more upside.
So watch the short interest in your stocks — particularly small caps with fewer shares outstanding, which are more succeptible to short squeezes — and be prudent about taking at least partial profits when these kinds of big moves happen.
Don’t fool yourself into thinking a gap up is deserved or long-lasting, particularly in stocks like RSH or BKS that have systemic problems that continue to weigh on their core business. At the end of the day, a short squeeze can’t fix margins squeezed even more by Amazon.com (NASDAQ:AMZN) in these retail dogs.
- Who’s the next Netflix short squeeze candidate? Alexander MacLennan weighs in. (The Motley Fool)
- Will the shorts return to Tesla soon? Steve Schaefer thinks so. (Forbes)
- A great list of how some of the most shorted stocks in the S&P 1500 have performed lately. (Bespoke Investment Group)
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.