A Big Short-Squeeze Is Taking Place In Europe

By Michael Msika, Bloomberg Markets Live reporter and commentator

It might be very early days, but it seems investors don’t want to start the year being heavily short on European stocks, especially not when it comes to the worst laggards of 2022.

The biggest losing stocks of last year are looking to put their awful performance behind them, starting 2023 in the best way possible. A basket of the 20 biggest stragglers of 2022 is up about 6% this week, more than three times the performance of the Stoxx 600.

“We are seeing strong evidence of the January effect,” says Cowen head of EMEA trading Carl Dooley, noting that the last time European stocks had a similarly poor year — in 2018 — underperformers “rallied hard” in the first month of the next year. This time round, he pointed to Faurecia, HelloFresh, SBB, Kion, Just Eat Takeaway, Zalando, GN Store Nord, Aroundtown and AMS as among those off the list of unloved 2022 names enjoying the brightest start.

There’s another common theme linking some of these stocks: a high quantity of shares out on loan, an indication of short-selling interest. Take Swedish real estate company SBB for example, with almost 23% of the free float available to borrow, according to S&P Global data. It’s up 10% this year, extending a rally since Dec. 20 to about 25%. Elsewhere, Zalando, Ocado, Aroundtown and HelloFresh all have more than 9% of their free float out on loan.

A similar picture of losers turning winners is evident in European sectors. Autos, real estate and retail are among the pace-setting industry groups, after they all severely underperformed in 2022. Banks look like the exception in the top six performing groups so far. Real estate was the second most-shorted sector after food retail by mid-December, according to S&P Global data.

“I think investors should be on really high alert for a short squeeze before we see another leg lower in equities,” says Vanda Research global macro strategist Viraj Patel. “Part of the reason for that is that we’ve got bond markets trading on recession fears, while equity markets are in this pessimistic, bearish sentiment state.”

Patel sees a possibility of a “Goldilocks state environment,” where inflation moves lower and economic activity holds up somewhat. “Could that be the template for the next couple of months? That’s certainly not priced in at the moment,” he said in a Bloomberg Television interview.

The short-covering trend shows up in the futures market too. For example, net futures positioning from asset managers and leveraged funds turned positive on the S&P 500 at the end of December, rising from a multi-year low. Meanwhile, European futures positioning has been relatively stable over the past two weeks, with investors marginally net long Euro Stoxx, while positioning in the FTSE 100 and DAX is moderatey net short and rising, according to Citigroup strategists.

“Investors have returned to their trading desks with some confidence about this new year,” says Pierre Veyret, technical analyst at ActivTrades. “It is, however, still hard to say if the current price action is being driven by real directional motivations from portfolio managers or if it is just a liquidity bull trap, covering some of last year’s short positions.”

Veyret cautions that a combination of high volatility and lower market liquidity is often treated as a dangerous indicator for stock traders.