Presenting The Best Trading Strategy Over The Past Year: Why Buying The Most Hated Names Continues To Generate "Alpha"
Just over a year ago, in "Presenting the most shorted stocks" we showed a simple chart highlighting the most hated/shorted Russell 2000 names with an even simpler expectation: in a market in which all the risk is being onboarded by the Federal Reserve, there is simply no more idiosyncratic risk, and as a result for those so inclined, and preferably running other people's money, a clear "alpha-generation" strategy in which hedging risk is no longer a concern, was to go long the most hated named.
Specifically we said:
What is one supposed to do with this data? For the overly aggressive out there, and those who are tired of watching paint dry, one option is to create an equal-weighted basket of the 20 most hated names, and hope for the arrival of the one catalyst that forces a massive squeeze. No doubt one or more companies in this list will file for bankruptcy and end up without any value: after all they are shorted for a reason. Yet, all it takes is for one name of 20 to jump tenfold in order to offset the full wipe out of half the names in the basket.
Are we saying this will happen, or any one company will perform as suggested? Of course not: we are not Cramer. This is simply the math. And since fundamentals don't matter in a world where Austrian monetary theory rules (i.e., the only thing that matters is the amount of liquidity entering or leaving the market at any moment), taking advantage of people who still naively believe that there are traces of rationality and efficiency in a market that is broken beyond any slavage value and short the worst names out there, may be one of the few "strategies" that work, besides of course predicting with 100% accuracy what side of the bed Mario or Ben will wake up on.
Since then two things happened:
i) a week later the Fed unleashed open-ended QE(ternity), which one year later has (once again) failed to spur any notable recovery in the economy (trailing GDP a year ago was higher than it is now, and full-time worker substitution with part-time jobs was only a phenomenon suggested here instead of being conventional knowledge), however it led to the latest stock market bubble reflation, where even as corporations have failed completely at growing their bottom lines, the PE multiple has expanded to grotesque levels and has pushed the S&P to new record highs.
ii) more importantly, the most shorted names have massively outperformed the broader stock market as day after day, week after week, those "hedging" long positions with hedge fund hotel shorts, got blown out of the water and were forced to cover shorts leading to the only significant "alpha" generating strategy available in this broken, centrall-planned market.
This is confirmed by the chart below showing the outperformance of the "Most Shorted Basket" compared to the overall market.
So in a world in which nothing has changed from a year ago, and where fundamentals still don't matter, what is one to do to generate an outside market return? Simple: more of the same and punish those who still believe in an efficient, capital-allocating marketplace and keep bidding up the most shorted names. After all, it was in December when Herbalife was trading in the mid-20s that we warned of an epic short squeeze potential in the name. It just hit a new 52 week high of $71.25/share.
Below, just like a year ago, we present the most shorted Russell 2000 names (those where one tweet from iCahn or an unexpected Microsoft announcement can lead to a 50% surge higher on absolutely nothing), those whose outperformance relative to the broader S&P is likely to continue until such time as the Fed is removed (perhaps by force) from micromanaging the risk of the overall market, and fundamentals once again do matter.
Until then, if it isn't unbroken, why unfix it.