Credit a ‘short squeeze’ for the stock market’s big two-day bounce

Short sellers covering their losses have been a major driving force behind the recent surge in the stock market. Hedge fund short sellers increased their bearish wagers in both individual stocks and macro-related securities after the volatile early April period triggered by President Trump’s tariff announcements and subsequent pause. This increased short position created a situation where short sellers were forced to buy back their borrowed stocks quickly to limit their losses, leading to a short squeeze.

The market rally seen in the past two days can be attributed to this phenomenon. As short sellers scrambled to cover their positions, the market experienced a surge in buying pressure, pushing stock prices higher. John Flood, a managing director at Goldman Sachs, highlighted the risk of a short squeeze in a note to clients, emphasizing that many hedge funds were caught on the wrong side of the trade.

Despite the rally, there are concerns about the sustainability of the upward momentum. While signs of easing trade tensions and positive comments from Treasury Secretary Scott Bessent fueled the market optimism, the rally started to fade as the Dow Jones Industrial Average pulled back from its highs. President Trump’s reassurance that he has no intention of firing Federal Reserve Chair Jerome Powell also helped boost sentiment, but the lack of high conviction buying from hedge funds suggests that the rally may not be backed by strong fundamentals.

Goldman’s Flood noted that hedge funds have not transitioned from short covering to outright buying on the long side, indicating a cautious approach from investors. The market will be closely monitored to see if hedge funds start buying on the long side and if longer-term investors step in to buy stocks they consider as fair value. Until there is more conviction behind the buying activity, the sustainability of the current rally remains uncertain.

Overall, the stock market’s recent rally has been driven by short sellers covering their losses, creating a temporary boost in buying pressure. However, the lack of strong buying conviction and the fading momentum suggest that caution is warranted as investors navigate the market’s current volatility.