Short-Squeezed Hedge Funds Are Now Getting Hit on Their Bullish Bets Too

(Bloomberg) -- With a full-blown retail raid targeting their short books, many of the stocks hedge funds are bullish on are suddenly in trouble, too. That has prompted the industry to cut their risk appetite at the fastest pace in more than a year.

Square Inc., Roku Inc. and Peloton Interactive Inc., among the industry’s favorite stocks, each tumbled at least 3% Tuesday while GameStop Corp. continued to lead a rally among companies with the highest short interest. Shares of the video game retailer spiked more than 65% in late trading after Elon Musk tweeted about it.

The Goldman Sachs Hedge Industry VIP ETF (ticker GVIP), tracking hedge funds’ most popular stocks, fell for a fourth straight day, the longest stretch since October. That coincided with a 15% rally in a basket of the most-hated shares over the stretch.

In a market where bearish wagers are backfiring like never before, one way to mitigate career risk might be to sell stocks that had previously been working -- even if that means parting with some beloved companies.

“The recent squeeze in heavily shorted stocks has been nothing short of extraordinary,” said Jonathan Krinsky, chief market technician at Bay Crest Partners. “If shorts cause too much pain, there is usually some repercussion on the other side as longs have to be sold to offset losses.”

Hedge funds are suffering as retail traders whipped up in chat rooms charge into heavily shorted names, fueling squeezes in stocks from Bed Bath & Beyond Inc. to AMC Entertainment Holdings Inc. Fund managers have been busy paring bearish bets, with hedge fund clients tracked by Goldman Sachs carrying out short covering at an almost unprecedented pace during the past two weeks.

But the long sides of their books are starting to feel the pinch too. On Monday morning, when stocks with the highest short interest soared as much as 11%, the GVIP fund tumbled almost 2%.

Such a squeeze not only hurts performance for hedge funds, it increases the potential size of a measure known as daily value at risk, both of which would prompt money managers to cut back risk, according to Kevin Muir of the MacroTourist blog.

Indeed, gross leverage, or a gauge of hedge fund risk appetite that takes into account long and short positions, on Monday experienced the largest active reduction since August 2019, data from Goldman Sachs show.

“The real question is whether this selling starts a negative feedback loop,” Muir wrote Monday. “Even though it might seem like the stock market bulls should be cheering the squeezes, their success might end up being the trigger that brings about the general stock market correction many have been waiting for.”

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