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Focus on Fundamentals

  • Internet traders have taken aim at select favored shorts among the hedge fund community, rallying countless retail investors to their cause. Last June, shares of bankrupt rental car company Hertz rallied over 500% in a week, as a group of investors bid up the stock despite clear fundamentals pointing to the company’s ultimate demise. The euphoria did not last. This month’s episode was initially concentrated in a select few names, namely GameStop, a video game retailer, Blackberry, a former leading cellphone manufacturer now more focused on software and security, and AMC, the troubled movie theater chain.
  • All three names characterize a broader group of companies with large institutional short bases, but which have for months been favorite long positions among retail traders active on popular investing-focused internet forums.


Recent events unlikely to cause a systemic issue

  • If this episode turns out like last June’s Hertz saga, the excitement could end as fast as it began. More importantly, some signs of stress among certain hedge funds is unlikely to cause a systemic issue in Citi’s view. Furthermore, Citi analysts prefer to stick to fundamentals-based investing, which may be more fruitful over the long run.
  • The 100 most shorted names in the Russell 3000 make up just 0.7% of market cap, and this episode may turn out to be another sideshow with little direct broad market impact.
  • Citi analysts note however that this episode comes at a time when several sentiment indicators have suggested growing levels of market complacency, including a spike in call option volumes relative to puts, falling intra-market correlations, and a drop in NYSE short interest. Indeed, after a significant rally in both growth and value equities since November, some consolidation remains possible in the short-run.




Implications for Portfolios

  • While market volatility may occupy day traders in the ensuing trading sessions, Citi analysts continue to expect the emergence from COVID-19 restrictions to dominate the economic and market dynamics in the coming year.
  • While Citi’s “Leave your Home” Basket has rallied 25% since vaccine news in November, the group has still underperformed those companies who benefitted from COVID-19 related disruptions by 93% since the beginning of 2020, and may have room to catch up.
  • In addition, Citi analysts also see an opportunity in more “traditional” but also fundamentally attractive areas like health care. Relative valuations in US and global health care are at 10-year lows, with long-term demographic tailwinds likely to drive strong share price growth.

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