Barclays says the GameStop short squeeze will not cause a broader market contagion

Published Fri, Jan 29 202110:17 AM ESTUpdated Fri, Jan 29 202110:36 AM EST

The wild trading in shares of GameStop — and the stock's large swings in either direction — has captivated the Street this week, but Barclays said the short squeeze won't have larger ramifications for the market. "The ongoing short squeeze in a few stocks by retail investors has raised concerns of a broader contagion," the firm said Friday in a note to clients. "While we believe there is more pain to come we remain optimistic that it is likely to remain localized." The fear is that the stresses caused by the short squeeze could ricochet to the broader market as shorts are forced to sell. A firm could be forced to sell other positions in order to cover losses from a short, for instance. The total value of short interest in the market is roughly $800 billion, according to Maneesh Deshpande, head of US equity and global derivatives strategy at Barclays. The value of short interest in stocks that have more than 20% of their available float — or the number of shares available to the public — sold short is $40 billion, meaning it's a small slice of the total. This week's trading frenzy has been concentrated in names like GameStop, AMC and Bed Bath & Beyond , all of which have more than 20% of their shares shorted, according to data from FactSet. Individual investors are creating short squeezes by piling into these names, while hedge funds that are short on the other side are rushing to cover their losses. They are promoting their activity on the wallstreetbets Reddit board, which has more than 3 million members. Short selling is a strategy in which investors borrow shares of a stock at a certain price in expectations that the market value will fall below that level when it's time to pay for the borrowed shares. Some have also voiced concerns that the deleveraging could lead to a widespread decline given that the market is already trading at a historically elevated multiple. But Deshpande noted that the jump in valuations is concentrated in a handful of companies, most of which have benefitted from the stay-at-home trend. Overall, companies within the S & P 500 index have reasonable valuations, he said. "The higher valuations for the Resilient stocks [names that benefitted from the pandemic] are justified to some extend given that they proved to be the 'defensive' stocks during this downturn in that their earnings were hardly affected by the pandemic," the firm wrote. Investors have begun to rotate into cyclical areas of the market as the Covid vaccine rollout spurs hope that some of the hardest-hit areas of the economy will bounce back later this year. Amid this rotation, Barclays doesn't expect the same outperformance from the "Resilient" stocks in 2021, but the firm also doesn't see large downside. "We do not expect a crash in these stocks given that as opposed to 2000 these are solid mature companies and their growth prospects are not unreasonably high as during the dot-com bubble," the firm said. However, Deshpande also acknowledged the newfound power of retail investors. While individual influence is small, investors banding together on social sites like Reddit can have a real impact. "The market action has been a wakeup call and retail traders are likely to continue to be a force to be reckoned with, which will likely permanently affect the business models of institutional investors," he said. - CNBC's Michael Bloom contributed reporting.

People enter a GameStop store in Alhambra, California on January 27, 2021.

Frederic J. Brown | AFP | Getty Images

"The ongoing short squeeze in a few stocks by retail investors has raised concerns of a broader contagion," the firm said Friday in a note to clients. "While we believe there is more pain to come we remain optimistic that it is likely to remain localized."

The fear is that the stresses caused by the short squeeze could ricochet to the broader market as shorts are forced to sell.

A firm could be forced to sell other positions in order to cover losses from a short, for instance.