What Is A Short Squeeze and Should I Care?
Warren Buffet has said that investment markets are not supposed to be exciting.
In fact, we would say that the more boring your portfolio is, the better. The best long-term results are going to be generated by compounding your capital over extended periods of time.
The market for some stocks has been anything but boring for the past few days. For those not watching the news, several stocks have recently endured short squeezes, which have resulted in volatile and parabolic upward moves in their price.
While the gyrations have had little effect on your investments at Sterneck Capital we thought we would take a minute to talk about what a short squeeze is, how it can happen and what the long-term implications of the recent events might be.
What is a short squeeze? To explain, I’m going to tell the story of Jodie and her quest for a Winter coat. Jodie lost her coat in early March. She knows she is going to need a coat because there is a late winter storm coming but she does not want to buy one today because she knows by the time April comes it will be Spring and coats will be sold at a big discount. Jodie makes a deal with the store. Instead of buying the coat, the store agrees to lend her one provided she returns a new coat on April 15th.
Jodie thinks this is a great deal she will get to use her coat now and will be able to buy a replacement to return to the store at the much lower spring sale price.
All is proceeding as planned until there is an unexpected large snowstorm on April 14th. Suddenly, there is huge demand for winter coats. At the same time, inventory is very low as most stores have sold their coats or removed them from the shelves for spring. Seeing that there is large demand and low supply stores raise their prices for coats. Not only are lots of people buying coats to wear but all the people who borrowed coats to return on the 15th, like Jodie, are also buying. Eventually, coats become almost impossible to find. People are willing to pay almost anything to buy a coat so they can return the one they borrowed as they promised. As prices rise people become more desperate to buy the few coats that remain, and prices go up and up.
This is a pretty good analogy for what is happening in the market in stocks like GME, AMC, EXPR, MAC and others. Investors borrowed stock believing they would be able to buy it back later at a lower price. Instead, the stocks went higher and when those who borrowed it try to buy it back they find there are few sellers, so prices move up in a parabolic manner.
The monetary implications of this are likely limited to a few traders and hedge funds. However, this type of market activity is usually indicative of some excessive speculation in the markets. For the most part, these events should have little effect on your SCM portfolio. However, we have made some modest rebalances for more risk averse clients. We continue to believe that making long-term strategic changes based on short term gyrations is a bad decision. However, given what has happened in the world in the last 12 months we are viewing the world with a touch more caution today then yesterday.