BALTIMORE (Stockpickr) -- Everything's hunky-dory over in the market right now. The S&P 500 has extended its year-to-date gains to more than 28%, consumer sentiment numbers are the highest they've been in months, and investors are feeling good again about the New Year.
But that doesn't mean that investors are bullish on everything right now. In fact, there's a long list of stocks they hate.
Hate is a powerful emotion in the markets. It's powerful because, more often than not, it's wrong. The fact is, the stocks that investors want to give coal to this Christmas are really the ones that could hand over the most gains in 2014. I realize that sounds anti-intuitive, but historically, buying Wall Street's hate list has paid off.
Over the last decade, buying the most hated and heavily shorted large and mid-cap stocks (the top two quartiles of all shortable stocks by market capitalization) would have beaten the S&P 500 by 9.28% each and every year. That's some material outperformance during a decade when decent returns were very hard to come by.
When I say that investors "hate" a stock, Im talking about its short interest. A stock with a high level of shorting indicates that there are a lot of people willing to bet on a decline in its share price and not many willing to buy. Too much hate can spur a short squeeze, a buying frenzy thats triggered by shorts who need to cover their losing bets. And with the rally we've been since last November, you can probably guess that there are lots of losing open short bets.
One of the best indicators of just how high a short-squeezed stock could go is the short interest ratio, which estimates the number of days it would take for short-sellers to cover their positions. The higher the short ratio, the higher the potential profits when the shorts get squeezed.
It's worth noting, though, that market cap matters a lot. Short sellers tend to be right about smaller names, with micro-caps delivering negative returns when the same method was used.
Today, we'll replicate the most lucrative side of this strategy with a look at five big-name stocks that short sellers are piled into right now. These stocks could be prime candidates for a short squeeze in the months ahead.