The Dow Slipped 23 Points Because a Broad Short Squeeze Brought the Pain

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Some investors may have had to liquidate long positions to cover their unraveling short bets on GameStop stock and others. All three major U.S. indexes ended in the red.

Stocks were challenged Tuesday, with the three major U.S. indexes falling. Several pressure points weighed on stocks, even as earnings continue to beat estimates.

The Dow Jones Industrial Average fell 22.96 points, or 0.07%, to close at 30,937.04. The S&P 500 dropped 5.74 points, or 0.15%, to end at 3,849.62, and the Nasdaq Composite slipped 9.93 points, or 0.07 %, to close at 13,626.06. The biggest gainer in the S&P 500 was fiber-network firm Lumen Technologies (ticker: LUMN), which saw shares surge 28.1%.

Tuesday’s losses covered areas of strength. Big tech stocks had an upbeat day, and with their collective market cap of several trillions of dollars, they kept the S&P 500 in the game. Microsoft (MSFT), for example, rose 1% into its earnings report, which hit the wires after the bell. The S&P 500’s movements are market-cap weighted.

But the Invesco S&P 500 Equal Weight ETF(RSP), which treats all stocks equally and surveys the breadth of the stock market’s movement, fell 0.5%. This indicates investors were mostly taking risk off the table, as many sectors suffered.

Comments from Senate Majority leader Chuck Schumer fed some of the pessimism. He said that additional fiscal stimulus could be more than a month away. Stocks, which have had a strong start to 2021, have priced in heavy fiscal spending. Sure, the mountains of cash piling up on consumer and corporate balance sheets is ready to be spent when Covid-19 vaccines catalyze reopenings, but more cash into the system also means more pent-up demand, which stocks have priced in. The most economically-sensitive stocks were solidly in the red Tuesday, with the Vanguard S&P 500 Value Index Fund ETF (VOOV) down 0.3%.

“In late-morning trade, selling pressure quickly picked up on the back of comments from Sen. Schumer,” wrote Tom Essaye, founder of Sevens Report Research, in a note.

Essaye also mentioned the activities of short sellers were also causing selling pressure in the morning. Several stocks have been soaring past nosebleed levels because short sellers have had to cover their positions, or buy back the stock, before it rises too fast, as there were few shares left to be shorted. GameStop (GME) stock rose 92%. Bed Bath & Beyond (BBBY) stock rose 20%. AMC Entertainment (AMC) rose stock 12%. That’s just to name a few. There may be a marketwide “short squeeze” in play, an event that occurs when bearish bets on stocks backfire, and end up pushing shares higher and higher as short sellers have to pay more for shares to replace stock they borrowed. Some investors have to liquidate long positions to cover their unraveling short positions. A short squeeze “allegedly resulted in some margin calls for some big long-short equity fund managers and that began to weigh on the broader market by midmorning.”

The market’s weakness might seem confusing to some, as companies are turning in solid earnings reports. By Tuesday, just over 15% of the S&P 500’s market capitalization had reported earnings. By Monday, the aggregate quarterly earnings per share for the index components had beaten estimates by 23%, according to data from Credit Suisse strategists. A normal beat is in the mid-single digits in percentage terms, historically. More than 85% companies had beaten estimates by any margin. But valuations are high, so a strong earnings stream in the near term is mostly priced in. Meanwhile, if earnings are to surge to the level analysts are expecting, it will be the successful rollout of effective vaccines that does that trick, not anything management teams can tell investors right now.

Separately, while some are concerned that global stocks are in a bubble, the People’s Bank of China made a comment that seems inflammatory to investors. The central bank said the loose financial conditions in China could create an asset bubble and the bank also withdrew $12 billion of liquidity from the banking system, causing short-term borrowing rates for banks to pop more than 2%. That puts a strain on lending and economic activity and it also could cause government bond yields to rise, making stocks less attractive. The Hang Seng Index fell 2.5%.

Considering all the headwinds, U.S. stocks actually held in pretty nicely. Optimism is still high.

Write to Jacob Sonenshine at