I was looking at Real Money's list of 20 Stressed Out Stocks and there are some interesting names. But one thing I would caution to those planning to short those names is to watch out for the dreaded bear-market bounce, often symptomatic of a short squeeze. This advice might be a little tardy, given that the S&P 500 moved off its recent lows of around 1,800 to rebound all the way back to its 2015 closing level of 2,044, before giving up ground Wednesday to close at nearly 2,037. Yet I couldn't help but notice that some of these formerly hated stocks were rallying like mad.
Don't get me wrong, I think the vast majority of short-sellers are mouth-breathing rumormongers, who exist to ruin companies and destroy corporate jobs. However, they usually have a decent starting point based on some kind of financial, operating or -- the big one -- accounting irregularity that could portend to a stock's downfall.
So, when I saw stocks that were heavily shorted starting to rise into the Draghi-Fed-PBOC rally that began in the third week of February, I was concerned. It is one thing to bounce back, but the movements I saw in some volatile names in biotech, energy and shipping made me very suspicious.
My sense is that there is a return to a more normal progression in the markets, as the short squeeze has mostly run its course. I am looking for a slow, orderly pullback as investors get ready for a first-quarter earnings season that should be mostly terrible.
Factset's weekly Earnings Insight newsletter showed last week that analysts were predicting an 8.4% earnings decline for the S&P 500 for the first quarter and that nearly 20% of S&P 500 companies were lowering guidance going into the end of the quarter. For example, 92 companies lowered guidance, while 26 companies raised it.
So, investors are probably asking themselves if the sharp decline in earnings from Corporate America is priced into the market. I would be tempted to say the S&P 500's Feb. 11 intraday low of 1,810 would make that a "yes," but after Wednesday's level of 2,037 -- 12.5% above the February low -- I have to say "no way."
So, that's where we sit now.
I have been doing this for 25 years and was always taught that high short interest can provide rocket fuel for out-of-favor stocks. This happened during the last six weeks, but ultimately it's not sustainable. At some point, quality will matter and companies that don't have operating and financial warts will outperform the ones that do. The shock of this recognition generally occurs during earnings season.
So, it's been good to have stressed-out portfolios during the last few weeks, especially in energy, as oil has rebounded nicely above $40 per barrel. But don't forget, there has also been a number of head fakes for crude prices in the last 18 months. Today's Energy Information Administration (EIA) inventory data showed a 9.36 million barrel increase compared to the analyst consensus of 2.48 million. Granted, those analyst estimates are reliably unreliable, but if the S&P 500's recent rise has been predicated on a sustainable shift in oil prices, I'd be really careful in buying what the market is selling.
As the quarter comes to a close, I believe all investors should analyze their portfolios to ensure their holdings are adequately priced for market risk.
Some investors may ask, "Shouldn't we do that every day?" Well, it turns out that not stress-testing portfolios has been a lucrative strategy since Feb. 11. However, I've been doing this long enough to know that a mean reversion will always occur and the results can be painful for those who ignore its inevitability.
