If you have been paying attention at all, then you would know that the stock market has started 2023 very strong. The S&P 500 is already up 8.6% YTD, its strongest start in 21 years.
Well-known stock market leaders such as Apple AAPL, Alphabet GOOGL and Meta Platforms META participated in the rally. But a surprising group is actually leading the charge. The best performing stocks of the year so far are those with the largest short positions.
Among the top performers are Carvana CVNA, up 178% YTD online car dealership, online furniture shop Wayfair W, up 93%, and electric vehicle company Lucid Group LCID, up 70%.
What is happening?
Many hedge funds that had built large short positions in these stocks during 2022 have been taken aback by this huge rally. While his thesis about these companies is likely correct, it appears that many overstayed their welcome and were forced to cover their leveraged short positions.
Some players were clearly late in the game in shorting. Shorting a company near its top is going to be much less risky than shorting it when the stock is already down 60% or 70%, even if it’s eventually going to zero.
Carvana in particular has a broken business model, low on profit, and high on stock-based compensation. CVNA is up nearly 200% this year, but is still down -95% from its high.
The path to zero for these stocks is not a straight line, and the larger the short float the more vulnerable they become to short squeezes, and that’s exactly what happened.
“What do you call a stock that’s down 90%? A stock that was down 80% and then halved.
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Meaning
What does this mean for the wider market?
Does it sound positive if the stocks leading the rally have broken business models, and no clear path to profitability?
In some ways it is just a mechanical unwinding of the worst-case participants. They managed their risk poorly and the market is bringing the pain.
On the other hand, it may make some participants suspicious. It’s not particularly reassuring that the companies leading the rally are the types of stocks that got pumped up during the bullish period in 2021.
buy this, not that
As exhilarating as trading one of these high-flyers can be, it is highly advised to avoid such stocks. Sure some hedge funds got burned going short last month, but these are the most undervalued stocks in the market for a reason.
Lots of quality stocks with proven business models are trading higher in this strong market. Meta Platforms looks like it has found its footing in this market. After getting crushed in the wake of the “metaverse” investment last year, the company has refocused, and sentiment around the company has reversed.
META also currently sports a Zacks Rank #2 (Buy), indicating its positive trend earnings revisions. Although investors at this point missed an opportunity to buy Meta shares at a one-year P/E below 10, it is still reasonably priced at 20 times forward earnings today.
Another stock with positive growth is Aflac AFL, the supplemental health and life insurance company. Insurance may not be the most exciting industry, boring is often conducive to good investments.
Aflac is a steady earner, with strong long-term returns and a 2.4% dividend yield to boot.
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In addition, Zack’s research currently has the AFL as a top recommendation with Zacks Rank #1 (Strong Buy). AFL continues to receive positive earnings revisions from analysts across all time frames.
Jax Investment Research
Image source: Zacks Investment Research
conclusion
The market is going through some very interesting times. It’s not often you see failing companies grow 100% in a month. Thankfully good businesses are also on the rise.
It looks like the macroeconomic environment that will challenge the stock market in 2022 is changing, and this is good news for the economy and the market. If the Federal Reserve can stay the course, vanquish inflation, and eventually bring interest rates back to an accommodative level, the market could continue its long-term march higher.
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Apple Inc. (AAPL): Free Stock Analysis Report
Aflac Incorporated (AFL): Free Stock Analysis Report
Alphabet Inc. (GOOGL): Free Stock Analysis Report
Wayfair Inc. (W): Free Stock Analysis Report
Carvana Company (CVNA): Free Stock Analysis Report
Meta Platforms, Inc. (Meta): Free Stock Analysis Report
Lucid Group, Inc. (LCID): Free Stock Analysis Report
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