Making money by betting a company’s shares will sink in value has become more challenging in recent weeks as markets rocketed higher and a growing wave of investors became ready to take on short sellers at almost any cost – even threatening their lives.
Short sellers – contrarian investors who bet against rising stocks, such as Jim Chanos’ Kynikos Associates, Carson Block’s Muddy Waters Research, and Andrew Left’s Citron Capital – have been called accurate forecasters of stock market returns by academics and market manipulators by critics.
This week, they’ve stepped into the limelight as bets against stocks including GameStop Corporation, AMC Entertainment Holdings, and BlackBerry crumbled in the face of huge demand from retail investors and algorithmic traders.
The rhetoric has escalated, with warnings online to “watch out” and even death threats, said people familiar with the matter, who asked to remain anonymous for their personal safety. Managers have asked authorities to investigate, the people said.
The most prominent battle this month has raged over the fortunes of video retailer GameStop, with prominent hedge funds betting its stock would fall while waves of retail investors sent the stock up more than 1,774%.
Left, whose Citron Research is widely credited with inventing the practice of publicly posting research that supports short bets and who has been at the center of the GameStop drama, said he was being trolled online. In addition, he said, one night pizza he hadn’t ordered showed up at his door and someone had created a fake Tinder account in his name.
Short sellers borrow stock in the hopes of buying shares back later at a lower cost to repay the loan and pocketing the difference.
“Short selling is inherently difficult and made more difficult because of low interest rates and government stimulus which have sent stocks roaring higher recently,” said Ben Axler, whose Spruce Point Capital specializes in forensic research that uncovers companies’ vulnerabilities and often bets their stock price will fall.
But 2021 has seen a new dimension, short sellers agreed, with platforms like Reddit and Robinhood becoming powerful communication and trading tools for retail investors, making it imperative for short sellers to expand their vision past investment banks’ research and established sites like Seeking Alpha and Twitter.
Data from Harvard College Consulting Group, which surveyed more than 230 investors under the age of 24 this month, show that “31% of young investors are looking to make ‘quick cash’ and 30% of young investors use Reddit.”
Now the cost to short has also surged, because with only a small GameStop ownership base among mutual funds there are fewer investors available to lend shares, said Ihor Dusaniwsky, managing director of predictive analytics at S3 Partners.
Shares of GameStop carry a fee of 30.58% to short. That makes them more than 100 times more expensive to short than shares of electric car maker Tesla Incorporated, which has the largest short position, as measured in dollars, of any US company, according to S3 Partners data.
The relentless surge upwards by stocks, including AMC Entertainment and Bed Bath & Beyond Incorporated, has created an expectation among investors of continuing gains.
Citron’s Left acknowledged that the wilder trading this year has had a real impact.
“I could take on a single 5-year-old,” Left told Reuters this week, but “faced with 1,000 5-year-olds, they could take me out,” he added. As GameStop’s stock galloped higher he exited his short positions. “I have respect for the market,” he said.
This short-squeeze illustrates tough lessons.
“Our job is to explain that companies are not what they are saying they are and what investors thought they were, and there is definitely a market for that at a time more people aren’t doing a lot of diligence on their investments,” said Sahm Adrangi, whose hedge fund Kerrisdale Capital often publishes research and makes short bets.
But “anything you get wrong will be amplified and you have to be very, very careful,” he added.
Spruce Point’s Axler said, “The bar for short sellers keeps getting higher.” Still, he expects short sellers will find their footing.
“We’ll have our time in the sun,” especially when interest rates start to rise again and government stimulus wears off, Axler said. – Rappler.com