The stock market had another good day on Wednesday, with the Nasdaq Composite (^IXIC 1.76%) moving higher by more than 1% as of 1:30 pm ET. Market participants generally pointed to an inevitable recovery from the bad performance of 2022, and also expressed confidence that the latest numbers on inflation that the Bureau of Labor Statistics will publish on Thursday morning will continue the trend to ease price pressures.
When you look at today’s top performers, however, you’ll see a lot of familiar names from companies that have had considerable financial trouble. Among those high-flying stocks are Bed Bath & Beyond (BBBY 68.60%) and caravan (CVNA 24.43%), who faced major headwinds that posed existential threats to their ongoing businesses. Although the shareholders of these companies will see amazing results on Wednesday, the gains will come largely from a phenomenon that is purely short-term in nature and could reverse at any time.
What happens with these two stocks?
The thing that Bed Bath & Beyond and Carvana have in common is that they’ve had a lot of investors questioning whether they can stay in business. Bed Bath & Beyond just announced yesterday that its revenue had fallen sharply in the holiday quarter, raising new concerns about its ability to stay afloat amid mounting pressure to get back on a growth trajectory. Indeed, with less than a month to go before needing to make a sizeable interest payment on part of its debt, the home goods retailer has many investors who believe it will not be able to continue operating without having some form of protection. or relief from his creditors.
Carvana is also struggling with its debt, as rising interest rates increase its financing costs even as used vehicle prices weigh on its bottom line. The car dealership still has a couple of years before part of its long-term debt needs refinancing, but with the worsening economic conditions, shareholders seem to be. more skeptical about Carvana’s future prospects than ever
Still, on Wednesday, traders couldn’t get enough of the two companies’ stocks. Shares of Bed Bath & Beyond jumped 44% at midafternoon on Wall Street, while Carvana has set for a growth of 23%..
Short squeeze value traps
The main problem with these stocks is that they have been hit hard during the past year, and that has attracted considerable interest from short-selling investors. Bed Bath & Beyond had 57% of its float and 32% of its outstanding shares sold as of mid-December, according to figures from Yahoo! Finance. Carvana’s short interest was even more extreme, with 80% of its float and nearly half of its outstanding shares used for short selling.
When there is so much negativity about a stock, it becomes extremely attractive to those who want to bet against it. However, the mechanics of short selling leave investors vulnerable to those who choose not to make their shares available for lending. Combine that with a limited number of shares outstanding in the first place, and short sellers may find themselves having to pay much higher prices to return the shares they borrowed. This is known as a short streak.
Short squeezes can lead to massive gains that are far greater than what Carvana or Bed Bath & Beyond have seen so far. However, at a certain point, those who hold to gain finally begin to contribute in their positions, easing the pressure and causing the end of the tight squeeze. Often, this results in the stock falling back and erasing recent gains.
Don’t fall for FOMO with subpar stocks
There are many stocks that have seen significant declines over the past year to do have good fundamental business prospects. In this case, bargain hunting can be a smart long-term strategy.
With many short squeeze stocks, however, bullish scenarios are unrealistic. If you see a stock jump on a day like today for no apparent reason, ask yourself if there’s a tight squeeze going on — and then remind yourself that you’ve probably lost faith in that stock’s ability to reverse and they lost a long time ago.