The Siren Song of Shorted Stocks: Why the Recent Rally Masks a History of Long-Term Pain
Heavily bet-against companies are soaring, but historical data from Deutsche Bank reveals a consistent pattern of underperformance. Here's what investors need to know.
A powerful but risky trend has taken hold of the market: heavily shorted stocks are on a tear. While exciting for day traders and a headache for short-sellers, a look at historical performance suggests that investors chasing these high-flying names may be setting themselves up for a fall.
Since the S&P 500 hit its 52-week low on April 8, the broader market has mounted an impressive comeback, rallying roughly 30%. However, this performance pales in comparison to the gains seen in the market’s most-doubted corners. According to data from Refinitiv, the FTSE Russell index of the most-shorted stocks in the U.S. has skyrocketed by more than 70% in the same period. This explosive growth rivals that of market darlings like Nvidia Corp. (NVDA), which has gained over 80%.
This surge has undoubtedly inflicted pain on those betting against popular “meme stocks.” A company like Opendoor Technologies Inc. (OPEN), with a short interest of over 20% of its public float, has seen its shares rally, punishing short-sellers. But for investors considering buying in now, a crucial warning lies in the long-term data.
A History of Underperformance
While brief, explosive rallies capture headlines, history shows they are the exception, not the rule. An in-depth analysis by Deutsche Bank reveals a sobering reality: over time, investors have made more money betting against these stocks than on them.
The bank’s research, which tracked a basket of the most heavily shorted stocks from 1985, found that this group underperformed the broader Russell 3000 index by an average of 6.2% annually. The conclusion is stark: despite occasional bursts of outperformance, a long-term strategy of buying heavily shorted stocks has been a losing game.
Rare and Short-Lived Rallies
The current rally is not without precedent, but history shows these episodes are infrequent and fleeting. Deutsche Bank identified a few key periods where shorted stocks defied gravity:
2000-2001: As the tech bubble deflated, the short basket outperformed the market by 19 percentage points.
2013-2014: A smaller rally saw the basket outperform by 9 percentage points.
The Pandemic Boom: In the most dramatic example, the meme stock frenzy propelled the basket to an astounding 142 percentage point outperformance over the Russell 3000.
The recent surge, which began in April, has seen the short basket outperform by 39 percentage points—the most significant gap since the pandemic-era mania.
Is the Market Getting Frothy?
The strong performance of often unprofitable, heavily shorted companies has led some to worry that market exuberance is reaching dangerous levels. However, Deutsche Bank strategists suggest there’s no need to panic—at least not yet.
They point to two key indicators that remain below extreme levels. First, demand for call options, a reliable contrarian signal for market tops, has not reached a fever pitch. Second, analysis from the bank’s team, including Binky Chadha and Parag Thatte, shows that overall investor positioning in stocks has only recently moved back to “overweight” levels after months of being underweight. This suggests there is still room for investment to grow before the alarm bells start ringing.
Even so, the bank advises caution. The combination of a rally in low-quality stocks and a recent rise in margin debt is a development investors should monitor closely. While the market may not be at a tipping point, the historical odds remain stacked against those who chase the siren song of a short squeeze.
