The great short squeeze market rally is over

Author: Value Investor

Date of publication: 2021-01-30

What we witnessed in the past nine months is an aberration on a grandeur scale. Nothing even close to this have we seen in our lifetime and probably will never see. While the economy was literally collapsing, the stock market just took off and lived the life of its own with no correlation (or very little of it) with the real world.

The were (and, probably, still are) two factors at play here:

  1. The abundance of liquidity - the trillions of dollars pumped into the economy through different stimulus programs.
  2. Squeezing “bears” out of their shorts (meaning their short positions, of course).

I would argue, that out of the two, the latter one played a much more important role. There is no surer and quicker way to make money in the market than by taking the opposite position to the one held by an investor whose position is leveraged (through futures or short-selling, for example) and drive the price of the underlying asset in your directing until the investor holding the leveraged position capitulates (closes the position with a humongous loss).

What we have witnessed in the past nine months was exactly that: individual and institutional investors and hedge funds were squeezed out of their short positions (or shorts) on a massive scale. This happened in stock index futures and shot positions on individual stocks. Tens of billions of dollars were transferred from short-sellers to short-squeezers. There was so much money made in this strategy, that even novice investors joined the chase.

So where are we now? I doubt that there is any appetite for short-selling is left in the market: any sizable short position almost immediately becomes a target. That means the market should return to its senses. The adjustment - a sharp movement down - is almost unavoidable. Hold on to your hats - the ride down will be as spectacular as the ride up.