Surging Dow stock's run is nothing but a short squeeze, strategist says

Trading Nation: Cisco shares surge

It may not be a comeback.

Cisco shares surged to 16-year highs this week, as the '90s tech darling posted better-than-expected earnings, but one strategist warns the rally is nothing more than a short squeeze.

According to Larry McDonald, founder of the Bear Traps Report, short interest ratio in Cisco has tripled since May. "Heading into earnings, the shorts were lining up," McDonald said Thursday in a "Trading Nation" segment on CNBC's "Power Lunch."

Cisco shares surged 5 percent on Thursday for their best day since February.

Over the past couple months, the percentage of tradable shares sold short in Cisco has gone from 1.2 percent to 3.4 percent, as investors have increasingly bet against the tech giant's run.

When investors go short a stock, they are betting it will go down by selling borrowed shares. As the market rises, many of those investors are forced to buy back those shares in hopes of avoiding future losses. That buying can drive a stock even higher, a dynamic known as a short squeeze, which is what McDonald thinks is happening with Cisco.

"That tells me you want to sell that because typically short covering rallies like this are usually short-lived, like a week or so, and then the stock will settle back down to a normal trading range," McDonald said.

The tech company is one of the four horsemen of '90s tech, along with Microsoft, Oracle and Intel — all seeing a big revival this year. But while Microsoft and Oracle have been hitting record highs, Cisco and Intel have failed to regain their dot-com bubble highs.

Like McDonald, Kim Forrest, senior portfolio manager at Fort Pitt Capital Group, said she has reservations about Cisco. "I don't buy into the stock, but I buy into the story."

Forrest said that while routers and switches are a large part of Cisco's business, profits have continued to decline precipitously. She emphasized that despite strong earnings, the company's guidance was rather conservative. "In a tech name, we'd like to be the owner of something growing faster," Forrest said.

Cisco is up nearly 19 percent this year but is still underperforming the tech sector, which is up more than 37 percent in 2017.

Disclosure: Kim Forrest's firm holds Cisco shares in some clients' taxable accounts. Neither she nor her family owns the stock.