Months after the “Meme Stock” and retail events of early 2021, fears of short squeezes resulting in massive losses are still very much on investors’ minds. Crowding among particular industries and individual stocks, combined with continued market volatility and increased retail investing, has maintained the conditions that have allowed more and more squeeze events to occur.
At the beginning of November, we saw these conditions converge on Avis Budget Group Inc (CAR). Avis announced much stronger Q3 earnings than the street had estimated on November 2nd. The earnings surprise resulted in a solid boost to the stock price at the opening bell, but that boost quickly turned parabolic, leading to several trading halts throughout the morning. The stock was up over 200% intraday before closing 108% higher than its previous closing price. On November 1st, the Wolfe QES US Broad Risk Model estimated CAR’s predicted annualized volatility at 57.13%. A 108% single-day jump translates to a 30 standard deviation move!
This upsurge wasn’t only about earnings. The key behind the anomalous spike was a high degree of short interest activity. As the price climbed due to increased optimism, short-sellers scrambled to cover their positions, thus skyrocketing the price far beyond all-time highs. Retail investors also hopped on the ride, coordinating purchases to drive the price higher and press hedge funds trying to cover.
Avis Budget Group Inc (CAR) Performance
S3 Partners’ Short Interest and Securities Finance Data provides innovative, up-to-date short interest and crowding metrics for the global equity markets. The partnership between Omega Point and S3 allows portfolio managers to integrate valuable insights around short interest activity, availability, rates, crowdedness, and more into their portfolio risk and construction processes. This week, we will use the S3 dataset to recap the Avis squeeze and discuss how managers can better protect against similar situations in the future.
S3 Squeeze Risk
In addition to its fundamental measurements of short interest in the market, S3 also offers unique proprietary scores designed to quantify the crowdedness and susceptibility of a stock to a squeeze event. For example, the Squeeze Riskscore incorporates a security's short crowdedness and its recent short side profitability to indicate the likelihood of future volatility and increased stock returns. By creating a score that uses multiple underlying short interest and trading metrics, S3 can produce a number more consistent, with a higher level of predictability than what we would get through a standalone short interest data point.
The Early Warning Signs
To put the Squeeze Risk score to the test, let’s return to CAR. Looking at CAR’s Squeeze Risk in the months leading up to its earnings call, we see some volatility in early September, bouncing between 60 and 80 before leaping to 100 on September 23rd, where it generally remained until the squeeze on November 2nd.
Avis Budget Group Inc (CAR) S3 Squeeze Risk Score
To gather more context behind the conditions required for such an extreme event and how S3's proprietary Squeeze Risk score accurately indicated such conditions, we observed a few of the critical short interest metrics investors tend to monitor.
The table below illustrates that there was short activity in Avis long before November. However, none of these measures likely would've sent up large red flags on their own. Borrow rates were low. Utilization indicated that around half of the shares for borrowing were available. 17% Short Interest as a % of Float is high, but there were 58 stocks with higher Short Interest % in the Russell 3000 Index as of September 23rd.
What makes S3's Squeeze Risk score especially powerful is that it also takes a stock's recent volatility and mark-to-market performance into consideration alongside the traditional measures we observed above. Below, CAR's volatility was minimal in late August but increased notably in early to mid-September. On September 22nd and 23rd, the stock climbed 6.3% and 8.1%, respectively. As the stock price increases, short-sellers are losing money on their trade and need to decide whether to ride it out or buy the borrowed shares.
Avis Budget Group Inc (CAR) Performance
Many short sellers of Avis Budget Group Inc (CAR) were hit with huge losses when the stock multiplied on November 2nd, but the warning signs were there. A portfolio manager who used S3's Squeeze Risk score to monitor short positions in their book would have likely minimized or removed the position entirely well before the squeeze. In a year filled with historic squeezes from the likes of GME, AMC, BBBY, and more, it is paramount for investors to weigh fundamental conviction against all of the factors that, together, set the stage for events like these.
How to Avoid the Squeeze
How do we catch the next squeeze before it happens? We started by filtering the Russell 3000 universe to find stocks with a Squeeze Risk score greater than or equal to 80. These stocks are at high risk of an extreme squeeze based on the degree of short crowding and short side profitability. Below, we've listed the two highest from each sector. It's worth noting that Avis remains at 100 as of November 19th. Consumer Discretionary is also a hot spot for squeeze risk, with a total of 20 stocks above 80.
In total, there are 45 stocks in the index with a Squeeze Risk above 80. Not only is it essential for managers to cross-reference a list of susceptible stocks with their direct portfolio names, but managers also need to know their indirect exposure as well. Portfolios that short ETFs or Index Futures, thematic or factor baskets, and more could indirectly have names at considerable risk of being squeezed. Even at smaller weights, the massive returns we've seen this year from these events will still have an impact. The short side of the book shouldn't be the only side getting any attention either. Managers should be cognizant of long-crowded names, especially those that are popular pair trades for heavily shorted stocks. In the case of a squeeze, hedge funds will be forced to unwind, which, in turn, drives the price of those long stocks in a downward direction.
Factor Spotlight will be on hiatus next week as we celebrate the Thanksgiving holiday with our families, but will resume with the next issue on Sunday, December 5.
In the meantime, if you are interested in exploring S3's data further or would like to evaluate your portfolio through the Omega Point platform, don't hesitate to reach out. If we don't hear from you, have a happy Thanksgiving!
US & Global Market SummaryUS Market: 11/15/21 - 11/19/21
- U.S. stock indexes ended the week mixed with the Dow falling 1.4%, while the S&P 500 and the Nasdaq Composite advanced 0.3% and 1.2% respectively.
- An announcement of a 20-day national COVID lockdown by the Austrian government startled the markets and sparked buying in government safe-haven bonds on Friday.
- The number of people who applied for unemployment benefits in mid-November fell for the seventh consecutive week and are approaching pre-pandemic lows.
- House Democrats passed Biden’s $1.85 trillion social spending agenda; the bill must now be approved by the Senate.
- Retail sales jumped 1.7% in October, on the back of e-commerce and holiday sales categories.
- U.S. markets will close for the Thanksgiving holiday on Thursday, with a shortened session of trading the following day to end the week.
Normalized Factor Returns: Axioma US Equity Risk Model (AXUS4-MH)
Methodology for normalized factor returns
- Profitability blazes upward yet again and sits at +0.75 above the mean after a stay in negative terrain just 2 weeks prior.
- Earnings Yield’s 7-week ascension shows little sign of slowing down as it approaches the Overbought threshold.
- Medium-Term Momentum moved up for a 4th straight week to cross into positive territory.
- Growth moves positive this week following last week’s unusual slide that put the brakes on its recent rocket-like trajectory.
- Value continues its 6-week string of weakness and currently sits at -0.74 SD below the mean.
- Market Sensitivity repeats last week’s position at the bottom of the leaderboard as it approaches negative territory.
Normalized Factor Returns: Axioma Worldwide Equity Risk Model (AXWW4-MH)
Methodology for normalized factor returns
- Profitability finishes on top for the 4th straight week and jumps midway into Overbought territory.
- Earnings Yield saw yet another positive week moving further from the mean.
- Growth’s stay in Oversold territory lasted just one week as it moves upward once again.
- Momentum moved upward for the 4th consecutive week leaving last month’s extended weakness well into the rear-view.
- Value extended its multi-week plunge and is now designated as Oversold.
- Market Sensitivity (Beta) continued its trend of recent weakness on its downward approach towards the mean.
- Exchange Rate Sensitivity saw a massive slide once again and finishes the week at the bottom of the global leaderboard.