The 2021 Financial Phrase of the Year: Short Squeeze

At the end of every year, the media industry likes to pull together the words and phrases that defined the past 12 months. The media outlets usually focus on one word or phrase for the year, but in 2020, most couldn’t agree on just one. The New York Times pulled together a list of 20 for 2020.

You can probably guess what several of these phrases were, but here’s a sampling: essential workers, flatten the curve, personal protective equipment or PPE, remote learning, social distancing, zoom, black lives matter, and, of course, unprecedented.[1]

There will likely be many contenders for the word or phrase of the year for 2021, too. Interestingly, the Oxford English Dictionary has already selected “vax” as its 2021 Word of the Year.

However, the financial media may disagree on what word or phrase defined 2021. Most market pundits and financial advisers would more likely select “short squeeze,” as it was one of the most-used phrases on Wall Street and better defines the action in the stock market in 2021.

Simply put, a short squeeze occurs when a heavily shorted stock rises rapidly in price, and short-sellers must exit their positions to limit their losses. Remember, short-sellers are betting a weak stock will continue to decline. So, when shares stage a surprise rally, these short sellers stand to lose a lot of money and will instead close out their positions.

We saw this phenomenon occur on several occasions this year. Most notably was the action in what many are calling “meme” stocks. In other words, these stocks have risen in popularity due to social media sites like Reddit. Some of the most well-known meme stocks are GameStop (GME) and AMC Entertainment (AMC).

GameStop has been the poster child for meme stocks and the so-called “Reddit Revolution” this year, so let’s take a closer look at its short squeeze and subsequent share action.

Back in early January, GameStop had a mind-boggling short interest of 141% of the company’s float. But members of the Reddit community joined forces, driving the stock to new heights. GME shares surged 1,625% in January alone. As Reddit users poured into GME in January, the short-sellers were “squeezed” out of the stock, selling their shares in an attempt to limit losses.

GameStop shares fell back to earth in February before the Reddit community once again ignited a flurry of buying at the end of the month. GME shares soared 553% in a two-and-half week period in late February and early March. As a result, by mid-March, the short interest in GameStop only accounted for about 15% of the company’s float.[2] Today, its float interest is around 12%.

The chart below exhibits the extreme price action in GME’s shares this year. Sharp inclines squeezed the short-sellers, followed by steep declines as investors bailed on the stock. Short-sellers and meme stock traders alike lost a lot of money in GameStop this year, given the erratic and volatile trading in the stock.

GameStop isn’t alone, though. Investors caught in a short squeeze of AMC Entertainment back in May lost an estimated $1.23 billion in one week.[3]

AMC Entertainment was reeling in the wake of the COVID-19 pandemic, and back in January, the company had nearly a 79% short interest.[4] The Reddit community poured into the stock on January 27, driving AMC shares more than 300% higher in one day. Retail investors moved in on AMC again in May, with the stock rising 418% in eight days.

As evidenced by the extreme action in both GME and AMC this year, a short squeeze occurs when a stock has an immense short interest, and a massive rally causes short sellers to cover their bets. Typically, a 5% short interest is considered “normal” for most stocks. The 141% short interest in GME and the 79% short interest in AMC were incredibly high—and retail investors took advantage of the considerable short interest to make a quick buck.

Now, with that said, just because a stock has a high short interest relative to its float doesn’t guarantee a short squeeze is looming—or that a big profit-making opportunity is imminent.

There are a lot of familiar names with significant short interests right now. Smiledirectclub has a 50% short interest. Avis Budget (CAR) and Bed Bath & Beyond (BBBY) both have around a 20% short interest. Big 5 Sporting Goods (BGFV) is estimated to have about 49% short interest. And Beyond Meat’s (BYND) short interest is around 33% of its float.[5]

All have the potential to be targeted as the next short-squeeze candidate, but they all also have the potential to cost investors a lot of money.

CNBC’s Jim Cramer recently summed up the short-squeeze phenomenon: “We now live in a world where individual investors like you have realized they can destroy the short-sellers whenever the short-sellers get too overconfident. … it created GameStop, and it created AMC, and I bet we’ll see many more of those until the hedge funds learn their lesson: Stay away from crowded shorts.”[6]

While we don’t always agree with Cramer’s advice or investing tactics, this is undoubtedly an area where we can agree. We may see a few more massive short-squeezes in the meme stocks in the coming months, but trying to bet on one side or the other is a costly gamble—and when it comes to gambling, we must remember that the house always wins.

The fact is that it won’t be long before institutional investors and hedge fund managers acknowledge the recent shift in the stock market. When they do, the unprecedented short-squeezes we experienced in 2021 aren’t likely to be repeated.

If you would like to discuss a more reasonable approach to selecting stocks, what we affectionately call “The Nicollet Way,” I would love to hear from you.

[1] https://www.nytimes.com/2020/12/18/style/words-of-the-year-2020.html

[2] https://www.reuters.com/article/us-retail-trading-gamestop-short/short-interest-in-gamestop-declined-to-15-vs-141-at-peak-s3-idUSKBN2BG28H
[3] https://www.cnbc.com/2021/05/28/amc-short-sellers-dealt-massive-1point2-billion-blow-after-stock-rally.html

[4] https://www.thestreet.com/investing/top-stocks-being-shorted-by-short-interest-gamestop-gogo

[5] https://money.usnews.com/investing/stock-market-news/slideshows/top-reddit-stocks-gaining-buzz?slide=5

https://www.yahoo.com/lifestyle/8-short-squeeze-stocks-could-195655110.html

[6] https://www.cnbc.com/2021/11/03/jim-cramer-expects-more-meme-stocks-like-avis-bed-bath-beyond.html