The rally in tech stocks has forced hedge funds to give up their short positions. That could provide tech stocks with a further lift. Or not.
Reports from Goldman Sachs and JPMorgan called the covering move the second-largest such unwinding in a decade, “surpassed only by the meme stock frenzy two years ago, when retail investors worked jointly to dismantle shortsellers bets against stocks.”
InvestorPlace’s Eddie Pan warned readers of such a short squeeze back on Feb. 7. Here’s what investors should know moving forward.
Tech Stocks, Short Covering and What This Memes
The Nasdaq is currently up about 11% year-to-date (YTD), roughly twice the gain of the S&P 500. Technology stocks like Tesla (NASDAQ:TSLA), Microsoft (NASDAQ:MSFT), Apple (NASDAQ:AAPL) and Meta Platforms (NASDAQ:META) have rallied as well. The rally has even reached poorer performers like Amazon (NASDAQ:AMZN) and Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL), which are both up YTD despite poor earnings.
A short-covering rally may have taken some of these names ahead of fundamental value. Microsoft is back to selling at 29 times earnings. Apple is selling at 26 times earnings. However, interest rates of 4% to 5% mean a bond investor can get a risk-free P/E ratio of 20 times to 25 times.
Investors can now either ride the rally or take profits and pull back. Shorts can put a floor under prices and removing them can be a trap door for bulls.
Since Feb. 15, tech stocks have been falling again. Pre-market trading this morning, Feb. 21, indicates that another down day is likely. Profit warnings from Home Depot (NYSE:HD) and Walmart (NYSE:WMT) could mean a recession really is in the cards.
What Happens Next?
The high-risk trade in this environment is to go short, betting that risk managers are right to fear the worst and that what we have seen so far is just a “bear market rally” ready to test its lows.
Investors looking at long-term returns might be advised to wait for lower prices and keep their financial powder dry. You can, after all, now get money for your money with minimal risk. That wasn’t true back in 2021.
On the date of publication, Dana Blankenhorn held long positions in AAPL, MSFT and GOOGL. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
