In our newest conversation on Bespokecast, we sit down with short seller Marc Cohodes. Marc manages his portfolio from San Francisco, and has had great success with high profile bear cases focused on frauds, fads, and failures in recent years. His investment industry experience dates to the early 1980s, and has helped him hone his process for picking out companies unlikely to succeed. Marc goes into detail on his approach, including how he thinks about finding potential shorts, timing, and risk management. He discusses with us recent successful shorts including Valeant, Concordia, and Home Capital Group, as well as another new bear case he has been building a position in Badger Daylight. You can read more about Badger at Marc’s website discussing the company. Marc is the first short seller we’ve had on Bespokecast, and we learned a ton about his approach to the market. We hope you do too! If you like what you hear today, you can learn more about our firm by visiting our website, bespokepremium.com. Bespoke…
This article is apparently doing the rounds and it purports to look at the supposedly new development of predatory short selling and uses the attack on Quintix by the US group Galucus as proof of this and along the way we get the usual dose of perceived wisdom from Gerry Harvey. Whenever such a piece on short selling appears it is predicated on a few basic assumptions.
- Short sellers drive down the price of instruments thereby engaging in a form of pseudo market manipulation
- Short sellers tend to target decent businesses and decent people and are therefore un-Australian
- Short sellers know what they are doing and are always profitable.
- Knowing which stocks are being shorted will give you an edge.
- Predatory short selling is a new development.
The article identifies a series of stocks that are among the most shorted on the ASX and I have reproduced this list below since it gives me a starting point for looking at some of the actual data surrounding these stocks.
What I wanted to look at was some of the performance figures that you might derive from shorting these stocks. The first thing I did was assume that exactly one year ago 1 shorted $1 of each of these stocks. I then valued these stocks as of last nights close and generated the following table.
The current value of this basket of stocks is $10.9, so in a year I have made $0.10, if I had simply bought the index and held it passively for the same period I would have made $0.11. Speculation has to be worth the effort, particularly speculation such as short selling that exposes you to substantial risks and can be regulatory and management nightmare. However, this sort of comparison is unfair since short selling is a trading strategy – it requires active management. So it would be more appropriate to look at the peak to trough movements in these stocks over the past year and this is what the table below tracks.
As can be seen some of these stocks have had substantial movements in the past year and there are only three where movement to the upside outpaces the move down. Interestingly, as a statistical fluke the average gain and average loss sits at 31%. From a trading perspective there always needs to be a recognition that stock prices move in both directions – unfortunately for passive investors fund managers only seem to accept that stocks prices move up. The value of short sellers is the knowledge that markets move in both directions and that this provides an opportunity for profit. However, this raises the additional question of whether short selling has both an influence on price and is utilized to make a profit. For this to occur large short selling positions need to be put in place whilst the stock is stagnant and then used to drive prices down. Therefore we should see an increase in the number of shorts before a stock falls and for this number to accelerate as pressure was brought to bear. To test this assumption I looked at some charts from the Shortman.com.au site which is used as the basis for the first graph in this piece and I have reproduced them below.
To be honest I am buggered if I can see a relationship between the lift on the number of short sellers and a decline in price. What I see is a mixed bag of short sellers being late, being early, not being there at all and getting lucky. Granted using the old Mark 1 eyeball is a dangerous thing and I cant extract the data to look at the true correlation between short sellers and price. But if it isn’t obvious then crunching it statistically to find some form of relationship isn’t reliable. So we come back to the basic questions I posed above and it is worth summarising an answer to each –
Short sellers drive down the price of instruments thereby engaging in a form of pseudo market manipulation
Not from what I can see. In fact if anything short selling is a boon to the market since it aids in liquidity, price discovery and as ASIC found much to its chagrin during the GFC it dampens volatility.
Short sellers tend to target decent businesses and decent people and are therefore un-Australian
People who complain about short selling fail to understand the basic mechanics of all trading is to elicit price discovery. The marekt then votes on its future view of this discovery – markets look forward not nackswards. So when you see the price of groups such as HVN get the wobbles it is the market voting about what it perceives to be the future prospects of this company in light of changes in technology, consumer bahvious and competition.
Short sellers know what they are doing and are always profitable.
Not from what I have seen
Knowing which stocks are being shorted will give you an edge.
See above – also consider the most you can make is 100% and that is functionally impossible. Simply Google best performing stocks of 2016 and this will give you an idea of the side of the market you want to be on.
Predatory short selling is a new development.
From my historical perspective I would say that short selling now is harder than it used to be. There are restrictions on naked short selling and the settlement system we operate under makes it hard to game the system. Back in the day when we had 14 day settlement you could short sell a company and buy it back before settlement and if you were careful no one was any the wiser. With instantaneous settlement this is actually very hard to get away with. As I said from a simple back office perspective short selling equities is a pain in the arse.
I came across this piece this morning. It claims that traders are taking up huge short sale positions in Tesla and they are paying a hefty penny in fees for the privilege of doing so. There are a few points in this that interested me. Whenever a financial journalist claims something is happening it is worth having a look at the raw data to see whether what they are on about is actually happening or is just an overblown figment of their imagination. I therefore downloaded the latest short sale interest data for Tesla to see if there had been a big spike in shorts. As one might expect over the past few weeks short sales have actually declined as can be seen. Short interest is robust but not spiking.
With a big of digging I found that a similar story appeared in the WSJ a few weeks earlier. The second point that interests me is as always the power of the personal narrative when linked to the conviction trade which seems to be what is driving these shorts. In many ways this is an ego based condition – I think it should go down therefore by dent of personal conviction I will make it go down. I dont follow Tesla (other than being fascinated by a their cars) so I have to look at a chart to see what was actually happening.
A quick an nasty look tells me that I might go short on a break blow $200 but the moment everyone starts talking about going short something I worry about a short squeeze. In some instances it is actually best to keep your gob shut….
One of the most devilish conundrums faced by traders is what to do when an instrument they are following gives a valid signal but this signal is either at an all time high or low. Such a situation has recently occurred with wheat, which according to my system gave a valid sell signal as it moved to a new low.
The rues that govern trading often run counter to the rules that seem to govern the rest of society – in our daily lives we seem to have a built in barometer of what we think things are worth. This barometer is generally correct in our daily lives. For example, we know that if on Wednesday we walk into our local baker and the price of a loaf of bread has risen from $5.00 to $15.00 that we are being ripped off. Our value scale in this instance has worked. Similarly, if we walk into a car yard and see a car advertised for a fraction of its value we know that something strange is going on and all sorts of alarm bells go off.
Yet, in trading this inbuilt sense of the economics of life is useless.Granted, there are people who think they know what something is worth and they generate all manner of models and hyperbole to justify this judgement. They make the mistake of believing that the market is somehow listening to their internal narrative. These are the sort of people who are convinced that oil is worth $100 a barrel and that the market is just wrong. The only value in trading that is true and correct at all times is the value given to something by the market. You will often hear statements along the lines that the market market is incorrect in its assessment of the value of something. As a basic principle the market can never be wrong – if we assume that the market is a synthesis of all opinions and knowledge then the price and trend it sets for an instrument is correct and anything else is simply titling at windmills.
As a basic rule we have no ides how high or how low prices will go.
What surprised you the most in the movie’s portrayal of the impending financial collapse?
It was surprising to me that some people, portrayed by Ryan Gosling and Christian Bale and others, actually got to the bottom of some of those mortgage products—figuring out that they were being fundamentally mispriced—when so many others didn’t. We had lots of quants—quantitative experts—and very smart people at the banks who presumably didn’t see it, or somehow it didn’t reach the right people. Alan Greenspan didn’t see it, Ben Bernanke didn’t see it, and neither did the head of the Treasury—super smart people who did have their fingers on the pulse of a million different things. Working at my bank, I talked to some of those high level people towards the end of 2007, when the first real cracks were happening in subprime loans, but it hadn’t spread to everything else yet and the big crisis came a year later. They really thought, Oh it’s just a subprime thing; it’ll be contained. So a big part of the debate about the recession—and this is simplifying a bit—is whether the banks were stupid or criminal in this. I’ll go on the side of stupid, not criminal. The fact that an organization can act stupidly even though it has a bunch of smart people in it, that’s interesting.
More here – Nautilus