Garbage stocks are on fire again
And a lot of hedge funds are probably hating it
It’s already been an . . . eventful year, but under the hood something odd and interesting is happening in the US stock market: the trashiest, most hated shares are soaring.
Goldman Sachs’ index of unprofitable technology stocks — which includes the likes of Planet Labs, AST SpaceMobile and Fluence Energy — is up 12 per cent already this year, despite taking a big whack yesterday from the Greenland crisis-induced crisis. Before that setback, the index had hit its highest level since January 2022.
The investment bank’s index of the most heavily shorted US stocks has done even better, jumping 18.3 per cent in just 13 trading sessions so far. There’s obviously some overlap between the two measures, but not as much as you’d think. They both separately seem to be reflecting a strong rally in the US stock market’s garbage sectors.
This is a bit odd. Trashier stocks tend to do best when the market is buoyant, as they are generally “high beta” — finance jargon for shares that rise more than the market when it is up (viz 2021), and fall more when it is down (viz 2022).
However, that really isn’t the case right now. Although the AI ebullience is still simmering in the background, this is on the face of it not a supportive environment for high-beta stocks. The S&P 500 is down 0.7 per cent this year, and the Nasdaq is dipped by 1.2 per cent.
So what’s up? Mahmood Noorani of Quant Insight argues that easier financial conditions — with US junk bond spreads narrowing sharply to a one-year low this week — understandably favours dodgier companies more than stronger ones. After all, the survivability of cash-generating blue-chip stocks is largely unquestioned, so riskier companies should benefit disproportionately more when borrowing costs fall.
This is probably a factor, but it seems unlikely that a 16 basis point drop in the option-adjusted spread of ICE’s US High Yield Index would be enough to trigger such a sharp renewed stock market trash grab in 2026.
Maybe retail investors are to blame for the flight to shite? After all, they were the main driver behind the massive rally in heavily shorted and/or unprofitable companies back in 2020-21.
There isn’t really any data, anecdotes or even noticeably different online vibes to suggest that retail investors specifically are powering this recent trash rally, but as Alphaville has written before, retail investors are arguably an ascendant force in the US stock market.
After all, they now account for over 20 per cent of overall trading volume — more than hedge funds and mutual funds combined — and far more than that in stocks that cost $5 or less. Which is squarely in trash-stock territory.
What does this mean though? Well, the violence of the rally implies that there have been some short squeezes, so Alphaville wouldn’t be surprised if we soon start hearing of hedge funds nursing some painful losses on their short books.
The worry is that this morphs into something more dramatic. Alphaville has detailed how a series of “quant tremors” shook systematic investment strategies last year, and it is interesting how many of them coincided with a rally in unprofitable and/or heavily shorted stocks.
The July and October setbacks were particularly heavily characterised by junkier parts of the equity markets being on fire, and Noorani, for one, speculates that this could be another “quant quake” in the offing.
Of course, none of the 2025 quant tremors ever escalated into something more meaningful for the broader market. Quant hedge funds really have learned the lessons of 2007. But we should probably keep an eye on the garbage rally anyway.
Update: Bloomberg News’ Justina Lee has reported that quants are indeed having a bad start to the year. From the IT company’s content marketing arm:
Quant hedge funds are kicking off the year in the red, as setbacks in crowded US stocks clobbered the strategies, reviving concerns about volatile returns in the sector.Early January marked the worst 10-day period for systematic long-short equity managers since October, with losses reaching 1%, according to prime brokerage data from Goldman Sachs Group Inc. Most of the pain was concentrated in US equities, Goldman’s Kartik Singhal and Marco Laicini wrote in a note, drawing parallels with the sharp drops that hurt quant portfolios in June and July last year.Losses at US quants amounted to 2.8% over the first two weeks of 2026, UBS Group AG estimated, based on its prime book. It noted that Friday had seen the sharpest one-day deleveraging since Dec. 22.Market moves spurred by US policies this week may have taken some pressure off, but the damage has already been done. It remains to be seen whether systematic hedge funds will be able to claw back some gains.Many quant funds ended 2025 in the black. However, they endured two violent loss-making periods, the first in early summer and then in October, when they were tripped up by reversals in momentum, coupled with a junk rally. Similarly, the most recent selloff stemmed from three main factors, according to Goldman: losses in crowded positions, short positions on high-beta names, and adverse idiosyncratic moves.“The idiosyncratic drag has been driven predominantly by the short book, similar to the June-July drawdown,” Singhal and Laicini told clients, adding that this time momentum strategies helped cushion the blow.