The stock market’s recent turbulence has left investors wondering which stocks are positioned for growth and which are likely to underperform, even if the broader market stages a rebound. A groundbreaking study, The Dynamics of Disagreement, sheds light on certain stocks that are structurally vulnerable to decline, regardless of market direction.
The Study’s Key Findings
Conducted by Kent Daniel (Columbia Business School), Alexander Klos (Kiel University, Germany), and Simon Rottke (University of Amsterdam), the study identifies a crucial pattern: stocks that are difficult to short-sell tend to be overvalued and subsequently underperform.
Short-selling requires borrowing shares before selling them. When a stock is hard to borrow due to high demand or limited availability, short-sellers are unable to correct its price, leading to inflated valuations. Once market conditions shift, these stocks become prime candidates for decline.
A well-known example is GameStop (GME) during its 2021 meme-stock frenzy. Due to extreme short-selling constraints, its stock price skyrocketed unnaturally, only to plummet by 81% over the next four years.
Two Types of Hard-to-Short Stocks That Lag the Market
The study highlights two distinct groups of stocks that consistently underperform:
- Constrained Winners – Stocks that have surged over the past 12 months but remain difficult to short. These tend to fall behind the market over the next five years.
- Constrained Losers – Stocks that have suffered significant losses in the past year and remain hard to short. These typically underperform for another 12 months before stabilizing.
Evidence-Based Market Performance
Historical data supports the study’s conclusions. A recent analysis of stocks in the S&P 1500, following the study’s methodology, found that:
- Constrained Winners lost an average of 8.4% (as of March 10, 2024), despite an overall S&P 500 gain of 9.3%.
- Constrained Losers performed even worse, averaging a 9.3% loss over the same period.
Stocks Likely to Struggle Going Forward
Applying these principles to the latest market data, the following stocks fall into the Constrained Winners and Constrained Losers categories:
Constrained Winners (Likely to Lag Over Five Years):
- Lumen Technologies (LUMN)
- Texas Pacific Land (TPL)
- GameStop (GME)
- Hims & Hers Health (HIMS)
Constrained Losers (Likely to Struggle for the Next 12 Months):
- Celsius Holdings (CELH)
- Moderna (MRNA)
- Super Micro Computer (SMCI)
- Cleveland-Cliffs (CLF)
Implications for Investors
Investors should consider these findings when making portfolio decisions. Stocks that are difficult to short due to limited availability may continue to underperform, even if the broader market enters a bull phase. By identifying potential laggards in advance, investors can make more informed choices and allocate capital to stronger performers in the current market landscape.
Final Thoughts
Understanding short-selling constraints and their impact on stock performance can be a game-changer. While some of these stocks may still see short-term gains, history suggests that their long-term trajectory remains uncertain. Keeping an eye on short-sell constraints and market trends can help investors navigate volatility with greater confidence.
