Big Day for Bad Stocks

What did I miss? As the Dow Jones fell 40 points yesterday, some of the market's worst companies -- financial stocks either majority owned by the government or still drowning in losses -- scored utterly insane gains.

Have a look:

Company

Wednesday's Gain

Volume

Average Volume

Citigroup (NYSE: C  )

10.2%

2.7 billion

379  million

CIT (NYSE: CIT  )

37.6%

292 million

58 million

Fannie Mae (NYSE: FNM  )

29.8%

117 million

16 million

Freddie Mac (NYSE: FRE  )

31.2%

53 million

8 million

Ambac (NYSE: ABK  )

34.1%

39 million

11 million

AIG (NYSE: AIG  )

62.7%

135 million

14 million

Yowzas. Why should these beleaguered names suddenly go berserk?  

They shouldn't. And that's why, if you're one of the fearless gamblers still seeking to pull a buck out of these companies, you'd be wise to clock your gains and move on.

AIG initially bounced on hope that its upcoming earnings report won't be as terrible as some thought, and on news that it's getting a new CEO. But that hardly explains the share-price explosion -- even if the insurer stops losing money, and regardless of who's in charge, it still owes taxpayers about $84 billion.

The most likely fuel behind the surge wasn't a newfound green shoot. It's short covering.

When investors short a stock, they borrow and sell shares they don't own. When they choose to close the short position out (short covering), they're forced to purchase shares in order to give them back to the investors who lent them. This buying activity can feed on itself if shares rise enough to cause other short-sellers to panic, or receive margin calls, forcing them to close their positions and buy shares. It's called a short squeeze. And it's likely what happened yesterday.

This happened to Volkswagen last fall: In what was described as "the mother of all short squeezes," the German automaker temporarily had one of the highest market values on the planet … only to come crashing back down to earth when the squeeze subsided.

Some of these financial shares are pure speculation -- bound to do unexplainable things -- but I'd expect a similar swoon in the coming days.

So, please, don't get too excited. If you were lucky enough to enjoy yesterday's bounce, take the money and run.

Start investing today -- just $7 per trade with Scottrade. Or find the broker that's right for you.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. The Fool has a disclosure policy.


Read/Post Comments (18) | Recommend This Article (32)

Comments from our Foolish Readers

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  • Report this Comment On August 06, 2009, at 12:41 PM, stocktrud wrote:

    Re:CIT, short squeeze???????? The numbers don't add up. There are around 50 million shares short. Over the past couple of days (as of right now) around 459 million shares traded. The numbers don't add up. Not saying short covering did not contribute, but there is certainly buying outside of it. I don't know about AIG, since I don't follow that one.

  • Report this Comment On August 06, 2009, at 2:12 PM, lindumsh wrote:

    Yes, you have missed something, and it's not the covering of shorts. Stocktrud is right, your explanation doesn't add up because your theory ignores the vast hedge fund resources that are not in equity positions, long or short.

    The DJI numbers have become irrelevant now because its the financials that will lead any rise in the indices. The potential for deal-making is on the near horizon. While there's much political complaint about growing bonuses, the very "problem" telegraphs that financial companies and banks expect to be very profitable. Someday people will be buying Heinz stock. First, investors want the company that will finance ketchup making.

  • Report this Comment On August 06, 2009, at 4:10 PM, cosmostein wrote:

    How long are we going to call these "bad stocks" the market dictates value, not fundamentals.

    What I find interesting is that of the six stocks listed, had you invested in the all but CIT in February or March you would have seen at least a return of double in that time, in Citi's case nearly four times.

    The market likes them, the analysts don't.

    If I cared what the analyst thought I would have sold all my shares at 8000 points when I was assured the dead cat bounce would fall back to 6500.

  • Report this Comment On August 06, 2009, at 4:23 PM, vishtr wrote:

    We are going to call them bad stocks until they no longer look like they are bleeding money and teetering on the brink of failure.

  • Report this Comment On August 06, 2009, at 5:19 PM, Vikinglord wrote:

    I bought some shares of CIT back when they were 80 cents and a few more around $1.30. Wondering if I should pack up and take the grand in profits or wait for them to hit double digits someday.

    If they don't go bankrupt, how could such a large company stay at a ridiculous price like this?

  • Report this Comment On August 06, 2009, at 5:22 PM, VegasMartin wrote:

    CITI went up on the "Cramer Effect." It got his blessing on Mad Money last night.

    www.ShootTheBears.com

  • Report this Comment On August 06, 2009, at 5:36 PM, ozzfan1317 wrote:

    I would take profits if you have shares in any of these companies. They are still highly speculative. Take the cash and run.

  • Report this Comment On August 06, 2009, at 5:41 PM, humble226 wrote:

    If you wait until a company is completely rock solid safe, you miss the biggest opportunities for profit. No one is denying that CIT is in a world of hurt right now, but they've also done a good job taking the first steps to recovery. They've secured financing to solve their immediate liquidity problems, they're actively working on restructuring out of court, and the bankruptcy that appeared so eminent a week ago is now looking less and less likely. To see the stock move back into the $1.50 range, which it was at before the bankruptcy scare mind you, was perfectly reasonable. Fear drove the price down to 40 cents, and smart investors willing to take a risk profited handsomely. Don't hate on the stock just because you didn't make money on it. :)

  • Report this Comment On August 06, 2009, at 5:55 PM, SockPuppetMan wrote:

    AIG is running a structured bankruptcy... less of a distressed sale of AIG's parts than a normal Chapter 11. Look who's in power... welcome to the United States of Goldman Sachs.

  • Report this Comment On August 06, 2009, at 7:58 PM, jwales9987 wrote:

    VegasMartin:

    Cramer didn't recommend CIT, he recommended C.

    But it's possible that people are stupid enough to have confused them and bought CIT instead.

  • Report this Comment On August 06, 2009, at 9:00 PM, jerryguru69 wrote:

    Ummm...OK; it is as good explanation as any. But how about the same thing that got people to buy GM off of the pink pages for a buck or two a throw: plain, old stupidity?

  • Report this Comment On August 06, 2009, at 9:25 PM, plange01 wrote:

    what recovery? in dreamworld?15 months of recession followed by 7 months in a depression.20% unemployment,1,600,000 forclosures so far this year,rising oil prices,interest and bankruptcysthe US is in a depression and its getting worse ...dont confuse a fools rally in the stock market with the real world...

  • Report this Comment On August 06, 2009, at 11:25 PM, stocktrud wrote:

    "Cramer didn't recommend CIT, he recommended C.

    But it's possible that people are stupid enough to have confused them and bought CIT instead."

    HAHAHA, that's right 292 million idiots.. no wonder the stock market is so unpredictable!

  • Report this Comment On August 07, 2009, at 5:45 AM, 8Lives wrote:

    Cramer recomended CIT.

  • Report this Comment On August 07, 2009, at 8:15 AM, MPowder wrote:

    I already know where some of the fools are. VegasMartin said CITI which assumes that he is talking about C or CITIGROUP jwales. He did not say anything about CIT.

  • Report this Comment On August 07, 2009, at 11:27 AM, CAPTAINWACK wrote:

    Ah...AIG is suddenly doing well or is it?

    Don't forget, in July AIG did a 20/1 reverse stock split. At pre-split the stock was selling for around $1.40 a share. So when you factor in the split differential, owners of pre-split stock need to see $28.00 per share just to break even. After that it's party time. So since US Government shares are pre-split prices the US share holders (that's me and you) are still in the dunk tank with no real profit.

    But those that purchased at post-split prices are in the money. Just send those profit checks to US Obama.

  • Report this Comment On August 07, 2009, at 7:33 PM, VegasMartin wrote:

    JWales, I said cramer recommended CITI, as in Citigroup (C), not to be confused with CIT. Cramer did not recommend CIT, I was solely referring to Citigroup. Sorry.

    www.ShootTheBears.com

  • Report this Comment On August 22, 2009, at 3:57 AM, piggybank819 wrote:

    Bad stocks? I followed recommendation of FOOL to buy FEED this May and SNDA back in two three years ago and lost so much. When the stocks go up, they call the stock GOOD STOCKS, when the stocks are not doing well, they call them BAD STOCKS. Really, there are a lot of analysis behind their calls? Hmm, lets see, do I hear any analysis of CIT, C, BAC, AIG going forward regarding the consolidating banking sectors and insurance sectors? Do I hear any unbiased comments regarding any restructuring efforts of these firms? So, CIT will fail and will not be able to work out solutions? Is that the same as saying "Oh, without Obama's plan to help banks, banks will fail?" So, we will not have any hopes and understanding about how our free market economy works out things both in good and in bad times? I don't know about people paying for subscription for FOOL and how much of a return that are getting. Yet, I bought F, C, CIT, BAC, GS, BZH, LVS, HOV all between Feb 2009 and now, and CIT is my most recent addition to my portfolio. Luckily I don't listen to analysts' calls, but that of my own. I think my return of 425% so far this year is better than if I subscribed to FOOL.

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