The stock market's bull run will continue despite short-selling in 'meme' stocks, UBS says

• The S&P 500 should deliver a strong return even as investors fight over shorted stocks, says UBS.
• COVID-19 vaccine rollouts and Fed policy will help keep the S&P 500's bull run afloat.
• Hedge funds may need to reconsider their strategy of heavily shorting stocks.

US stocks should continue their bull run this year, buoyed by stronger corporate earnings even as hedge funds defend themselves against the rush of retail investors challenging their short-selling positions, according to UBS.

The "explosive gains" in recent weeks in shares of video-game retailer GameStop and other so-called "meme" stocks including movie-theater chain AMC, have forced hedge funds to cover their positions in the heavily shorted names. Such "violent" moves have sparked volatility in the broader equity market and a slide in the S&P 500 last week.

However, the UBS analysts told clients not to fret the short-term volatility.

"We don't think the modest 3.7% selloff in the S&P 500 is indicative of a fundamental shift in the outlook for the economy and corporate profits," said Solita Marcelli, chief investment officer for the Americas, and David Lefkowitz, head of Americas Equities, at UBS Global Wealth Management, in a research note Tuesday.

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"In fact, earnings season results have been robust. S&P 500 EPS are coming in 20% better than expected and forward estimates are being revised higher," they wrote.

Netflix, JP Morgan & Chase, Johnson & Johnson, and UPS are among big Wall Street names that have recently turned in better-than-expected quarterly results.

Accommodative monetary policy at the Federal Reserve, stimulus funds sent to Americans by Congress to help cope with the COVID-19 crisis, and the rollout of coronavirus vaccines are other factors that should push US stocks to generate a double-digit return, the analysts said.

But the UBS analysts warned that Wall Street should be prepared for retail investors inspired by online forums such as the Wall Street Bets subreddit to take up the defense of shorted stocks, telling clients that further "speculative" activity can still increase risks in certain segments or the broader market as a whole.

"Hedge funds that regularly short stocks may need to rethink their strategies," said UBS. "Still, while equity market volatility could remain elevated in the near term, we think this bull market remains firmly intact."