GameStop's (GME) meteoric rise and subsequent drop are forcing institutional investors to reconsider if short-selling individual stocks is a viable risk control strategy.
If you're unfamiliar with the GameStop short squeeze, I discuss it in the following podcast. However, if you feel like you have a good understanding of what happened, skip below to read more about how I think the post-GameStop world may create investment opportunities.
Insurers, endowments, and pension funds represent the bulk of investable hedge fund assets and volatility-averse investment committees aren't likely to risk exposure to another multi-sigma, black swan event.
The rerating of risk in models could result in redemption letters being sent to hedge funds embracing single-stock shorting and the embrace of firms offsetting long exposure by shorting baskets, such as the S&P 500 (SPY).
It's unclear if this shift may mean for the broader market, but it suggests opportunities may exist in heavily-shorted individual stocks with favorable characteristics, such as improving earnings, insider buys, or positive seasonality. Why? Because redemption letters would cause additional short covering in individual stocks at the same time that long-only investors continue accumulating because of improving fundamentals or money flow.
In 2003, we determined high short interest alone produces variable results, but when it correlates with other factors in our model, it can provide alpha-friendly tailwinds. I discuss our 7-factor model more here, but in short, our methodology incorporates seven factors impacting future stock prices:
- Forward earnings growth expectations
- Historical trends in reporting earnings that beat Wall Street estimates
- Insider buying
- Short-term and long-term institutional money flow
- Forward valuation relative to historical valuation
- Contra-trend short interest analysis
- Quarterly seasonality over the past decade
Strong-scoring high short interest stocks
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