In the war between Wall Street and Main Street that took shape in January, a few small, heavily shorted companies, including GameStop, grabbed a lot of attention when investors banded together to execute a short squeeze – driving up the companies’ stock prices, which in turn forced short covering and drove the prices up further.
This month’s commentary will explore this so-called GameStop Affair. We’ll take a look at the underlying characteristics of a group of heavily shorted target stocks to demonstrate how our investment process evaluates them. In general, the stocks that experienced a short squeeze in January are largely inconsequential to our investment strategies in Active Quantitative Equity (AQE). They are fundamentally unappealing over the longer time horizon that we care about most.
Our stock selection process in AQE rests on three key themes – value, quality, and sentiment. Risk is also a critical consideration in our portfolio construction process. Viewed through the lens of these investment dimensions, the cohort of stocks with the highest positive return in the last two weeks of January (including GameStop) were higher risk, lower quality, and even showed poorer investor sentiment compared to the average stock in the Russell 2000 index. In short, these stocks were unattractive on all the dimensions of our investment process (see Figure 1).
One might have expected that this cohort of stocks would have shown strong investor sentiment during this period. Sentiment is based on how market participants collectively perceive a stock’s future earnings, profitability and growth, which we measure along multiple dimensions. One of these dimensions focuses on the hedge fund industry and includes measures of short interest data. The more heavily shorted a stock, the more negative the sentiment.1
Based on all of this, it’s probably not surprising that we don’t have much exposure to the cohort of stocks that recently become subject to short squeezes in our strategies, due to their fundamental lack of appeal over the time horizon that matters most for our investment approach. Some of these stocks did experience a massive surge in returns over a short period of time, only to come down again. But the price moves were so significant – up to 800% returns in some cases – that they weighed disproportionately on market returns.
Expressed in attribution terms, the heavily shorted cohort contributed around +1.3% to the total return of the Russell 2000 in the last two weeks of January, while the rest of the stocks in the index contributed around -3.5%. While it would be nice to have a contribution to returns as large as this for a couple of weeks, the fall from grace can be just as swift. The same heavily shorted cohort of stocks detracted from Russell 2000 returns by -0.6% between the end of January and February 12, while the rest of the index contributed +11% in the same period.
Our process typically avoids the sorts of companies that experienced extreme trading activity in January. The action of these companies is largely irrelevant to the returns we are seeking to deliver to our investors, but the speculative phenomena we have observed in financial markets in the past six months or so is yet another signal that decision making by the marginal investor is not being driven by the underlying fundamentals of companies. We believe these conditions are unsustainable.
1Except for rarer occasions where extremely shorted stocks can experience a short squeeze. We allow for that potential in our signal by including an adjustment in the metric for stocks that are more likely to experience a squeeze. For example, in the latter half of January, out of the 50 most heavily shorted stocks in the market (as measured by percentage of outstanding shares shorted), five that were viewed at highest risk for experiencing a short squeeze were adjusted to avoid taking the most negative view on their sentiment. Of course, this doesn’t mean that these five stocks registered positive sentiment – in fact our assessment of sentiment overall for these stocks remained negative despite the adjustment. And, because they were unattractive on virtually every other dimension of our investment process, we largely avoided these five stocks in our portfolios during this period.
State Street Global Advisors Worldwide Entities. Abu Dhabi: State Street Global Advisors Limited, ADGM Branch, 42801, 28, Al Khatem Tower, Abu Dhabi Global Market Square, Al Maryah Island, Abu Dhabi, United Arab Emirates. Regulated by ADGM Financial Services Regulatory Authority. T: +971 2 245 9000. Australia: State Street Global Advisors, Australia Services Limited (ABN 16 108 671 441) (AFSL Number 274900) (“SSGA, ASL”). Registered office: Level 15, 420 George Street, Sydney, NSW 2000, Australia. T: 612 9240-7600. F: 612 9240-7611. Belgium: State Street Global Advisors Belgium, Chaussée de La Hulpe 120, 1000 Brussels, Belgium. T: 32 2 663 2036. F: 32 2 672 2077. SSGA Belgium is a branch office of State Street Global Advisors Ireland Limited. State Street Global Advisors Ireland Limited, registered in Ireland with company number 145221, authorized and regulated by the Central Bank of Ireland, and whose registered office is at 78 Sir John Rogerson’s Quay, Dublin 2. Canada: State Street Global Advisors, Ltd., 1981 McGill College Avenue, Suite 500 , Montreal, Quebec, H3A 3A8, T: +514 282 2400 and 30 Adelaide Street East Suite 800, Toronto, Ontario M5C 3G6. T: +647 775 5900. France: State Street Global Advisors Ireland Limited, Paris branch is a branch of State Street Global Advisors Ireland Limited, registered in Ireland with company number 145221, authorized and regulated by the Central Bank of Ireland, and whose registered office is at 78 Sir John Rogerson’s Quay, Dublin 2. State Street Global Advisors Ireland Limited, Paris Branch, is registered in France with company number RCS Nanterre 832 734 602 and whose office is at Immeuble Défense Plaza, 23-25 rue Delarivière-Lefoullon, 92064 Paris La Défense Cedex, France. T: (+33) 1 44 45 40 00. F: (+33) 1 44 45 41 92. Germany: State Street Global Advisors GmbH, Brienner Strasse 59, D-80333 Munich. Authorized and regulated by the Bundesanstalt für Finanzdienstleistungsaufsicht (“BaFin”). Registered with the Register of Commerce Munich HRB 121381. T: +49 (0)89-55878-400. F: +49 (0)89-55878-440. Hong Kong: State Street Global Advisors Asia Limited, 68/F, Two International Finance Centre, 8 Finance Street, Central, Hong Kong. T: +852 2103-0288. F: +852 2103-0200. Ireland: State Street Global Advisors Ireland Limited is regulated by the Central Bank of Ireland. Registered office address 78 Sir John Rogerson’s Quay, Dublin 2. Registered number 145221. T: +353 (0)1 776 3000. F: +353 (0)1 776 3300. Italy: State Street Global Advisors Ireland Limited, Milan Branch (Sede Secondaria di Milano) is a branch of State Street Global Advisors Ireland Limited, registered in Ireland with company number 145221, authorized and regulated by the Central Bank of Ireland, and whose registered office is at 78 Sir John Rogerson’s Quay, Dublin 2. State Street Global Advisors Ireland Limited, Milan Branch (Sede Secondaria di Milano), is registered in Italy with company number 10495250960 - R.E.A. 2535585 and VAT number 10495250960 and whose office is at Via Ferrante Aporti, 10 - 20125 Milano, Italy. T: +39 02 32066 100. F: +39 02 32066 155. Japan: State Street Global Advisors (Japan) Co., Ltd., Toranomon Hills Mori Tower 25F 1-23-1 Toranomon, Minato-ku, Tokyo 105-6325 Japan. T: +81-3-4530-7380. F: 81-3-4530-7329. Financial Instruments Business Operator, Kanto Local Financial Bureau (Kinsho #345) , Membership: Japan Investment Advisers Association, The Investment Trust Association, Japan, Japan Securities Dealers’ Association. Netherlands: State Street Global Advisors Netherlands, Apollo Building, 7th floor Herikerbergweg 29 1101 CN Amsterdam, Netherlands. T: 31 20 7181701. SSGA Netherlands is a branch office of State Street Global Advisors Ireland Limited, registered in Ireland with company number 145221, authorized and regulated by the Central Bank of Ireland, and whose registered office is at 78 Sir John Rogerson’s Quay, Dublin 2. Singapore: State Street Global Advisors Singapore Limited, 168, Robinson Road, #33-01 Capital Tower, Singapore 068912 (Company Reg. No: 200002719D, regulated by the Monetary Authority of Singapore). T: +65 6826-7555. F: +65 6826-7501. Switzerland: State Street Global Advisors AG, Beethovenstr. 19, CH-8027 Zurich. Authorized and regulated by the Eidgenössische Finanzmarktaufsicht (“FINMA”). Registered with the Register of Commerce Zurich CHE-105.078.458. T: +41 (0)44 245 70 00. F: +41 (0)44 245 70 16. United Kingdom: State Street Global Advisors Limited. Authorized and regulated by the Financial Conduct Authority. Registered in England. Registered No. 2509928. VAT No. 5776591 81. Registered office: 20 Churchill Place, Canary Wharf, London, E14 5HJ. T: 020 3395 6000. F: 020 3395 6350. United States: State Street Global Advisors, One Iron Street, Boston, MA 02210-1641. T: +1 617 786 3000.
For use in EMEA: The information contained in this communication is not a research recommendation or ‘investment research’ and is classified as a ‘Marketing Communication’ in accordance with the Markets in Financial Instruments Directive (2014/65/EU) or applicable Swiss regulation. This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research.
Important Risk Information
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
The views expressed are the views of Active Quantitative Equity through February 18, 2021, and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Investing involves risk including the risk of loss of principal. Quantitative investing assumes that future performance of a security relative to other securities may be predicted based on historical economic and financial factors, however, any errors in a model used might not be detected until the fund has sustained a loss or reduced performance related to such errors.
The trademarks and service marks referenced herein are the property of their respective owners. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.
© 2021 State Street Corporation.
All Rights Reserved.
Expiry date: February 28, 2022
Adtrax Number: 3458696.1.1.GBL.RTL