Laggards are hitting the high notes so far this August, with 2020's weakest plays gaining ground in thinly traded late-summer conditions. Banks, airlines, cruise ships, casinos, and other groups posting losses as a result of the pandemic are getting scooped up at the expense of big tech, with the Nasdaq 100 trending lower since July 31. Tesla, Inc.'s (TSLA) five-for-one stock split should improve sentiment on Wednesday, but the news is unlikely to yield a long-lasting turnaround.
Needless to say, 2020's top-performing stocks are extremely overbought after momentum-fueled rallies that are now generating modest profit-taking. A bull market is expected to "float all boats," but this August bid may have other, less bullish origins due to the recent participation of "Robinhood traders," the popular moniker for the crowd of young market players who used their stimulus checks to open commission-free trading accounts.
A stock split is when a company divides the existing shares of its stock into multiple new shares to boost the stock's liquidity. Although the number of shares outstanding increases by a specific multiple, the total dollar value of the shares remains the same compared to pre-split amounts, because the split does not add any real value.
Short Covering Driving August Uptick
This speculative capital is seeking a new home after bidding up big tech favorites well above commonly accepted valuation levels. Beaten-down COVID plays look like obvious choices in the optimistic summer tape, especially with the recent infection wave flattening out and rolling over. However, most infectious disease experts still expect the pandemic to return in force this fall and winter, perhaps surpassing last winter in scope and lethal damage.
That isn’t stopping the buying crowd because these are short-term traders addicted to flipping positions at a rapid pace. Keep this in mind when you look at the price charts posting the strongest gains right now because nearly all of them show active downtrends and major resistance levels that are unlikely to break until the pandemic runs its course or an effective vaccine is widely available.
Short covering is also driving the late-summer uptick. The Nasdaq exchange just reported that July short interest in all securities fell to the lowest level since April. It's no coincidence that big tech stalled at the same time, highlighting the impact of short selling in 2020 price action. And it makes perfect sense that groups taking off in August rallies are also the most shorted stocks of the year due to plunging revenues and continued pandemic headwinds.
Short covering refers to buying back borrowed securities in order to close out an open short position at a profit or loss. It requires purchasing the same security that was initially sold short and handing back the shares initially borrowed for the short sale. This type of transaction is referred to as buy to cover.
Price Levels to Watch
You can check out recent technical analysis on August's top rally plays, with key price levels, here:
- Cruise Ships: Royal Caribbean (RCL) Posts Greater-Than-Expected Q2 Loss
- Banks: Buffett's Bank of America (BAC) Position Draws Muted Response
- Transports: Curve Flattening Lifts Transportation Stocks
- Airlines: Airline Stocks Could Charge Higher in Short Covering Rally
- Casinos: Wynn Resorts (WYNN) Could Test March Low
A common thread runs through these articles, although some calls miss the mark. Nearly all laggards stopped falling in July and settled into small-scale basing patterns that have now acted as platforms for higher prices. However, they're still trading below their 200-day exponential moving averages (EMAs), except for the airline-heavy transports. This level marks the dividing line between bull and bear power, so it makes sense to look for aggressive profit-taking when rallies hit or breach these barriers.
The Bottom Line
Stocks that have been laggards in 2020 have taken off in momentum rallies, fueled by short covering, but the upticks should stall and reverse as heavy overhead supply comes into play.
Disclosure: The author held no positions in cruise ships, banks, transports, airlines, or casinos at the time of the publication.