Die Meinung

Short Sellers' Short Revenge

The recent market plunge was short sellers’ paradise. Is it an offence to make gains on the back of a disaster? The point is, attempts at banning them, let alone closing markets, are misguided and can’t be warranted.

Myret Zaki

Deutsche Version

The coronavirus market selloff was a bonanza for some. The last 2,5 months have been pure bliss for short sellers, who made more than 50 billion dollars in mark-to-market profits just between February 24 and March 3 on their overall U.S. positions, according to data from S3 Partners. Some short sellers had their eye on the coronavirus since January.

Myret Zaki

Myret Zaki started in 1997 as a junior analyst in a Geneva private bank where she learnt the basics of equity research, before joining the daily newspaper «Le Temps» in 2001, where she was in charge of the finance section for 9 years. When the financial crisis broke in 2008, she wrote the investigative book «UBS, am Rande des Abgrunds» (originally published in French as «UBS, les dessous d'un scandale»), for which she received the Schweizer Journalist prize. She joined «Bilan» magazine in 2010 where she became Chief Editor from 2014 to 2019. Between 2010 and 2016, she wrote three other bestselling books, about Swiss banking secrecy, the end of the Dollar reserve status, and the rise of the shadow banking system. She has a Political Science Bachelor from the American University in Cairo and an MBA from the Business School of Lausanne. She is now a freelance columnist and a consultant in influencer and opinion leader strategies.
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Short sellers like Mark Spiegel of Stanphyl Capital Partners reportedly put a «really big» short position on the Nasdaq, because most of the companies in that index have supply chains going through Asia, according to Institutional Investor. Among the most profitable trades was the very stock that had spiked 260% over the previous 3 months: Tesla. Having triumphed against short sellers for a whole quarter, Elon Musk ended up losing the fierce battle opposing him to the Tesla bears, when his stock plunged up to 60% between February 19 and March 18.

In this crisis, short sellers are once again blamed for causing the market drops. Shorting gets demonized at every crisis, and it is understandable. Especially during this pandemic of historic proportions. On a decency level, it could even be argued that earning so much money on the back of a collective disaster shouldn’t be permitted. That ill-gotten money should be taken away and used for public purposes.

But no country went that far. Euronext simply banned new short positions from March 18 to April 16, including when initiated via derivatives, but so far it didn’t stop markets from falling. Similarly, short sale restrictions were introduced in the US, but haven’t stopped indices from sliding either. Elon Musk in the US, or Nick Hayek (Swatch Group) and André Kudelski (Nagra Kudelski Group) in Switzerland, are among the bad tempered CEOs who’ve been blaming them every now and then over the last decades.

It's the company's fundamentals, stupid

But a bearish position only exploits opportunities created by the company’s own figures and performance. If a company is meeting success, it is heavily armoured against shorts. Tesla is a good example. Its previous mind-boggling surge totally squeezed short sellers for months, when investors were convinced of the investment case, while sellers couldn’t do anything to counter the bullish strength. Shorting can also bring a healthy offsetting to some exaggerations. If WeWork was listed and could be shorted, it may have rebalanced part of its crazy overvaluation. The same goes for the general market: what we’re seeing is the bursting of the overstimulated bubble in passive investing, and short sellers are only taking advantage of it.

Short selling can be aggressive, harassing, but it is the flip of the same gamble coin, a full part of the investing deal. In a plunging market, short sellers do pressure the market downwards, especially when heavily leveraged. But calling them out on their indecent gains would require us to go also after the excessive bubble-era surge we’ve seen for an extended period. In any case, short sellers’ bans come against a general backdrop of persistent intervention, or calls for intervention from authorities, which simply cannot be warranted.

The very idea of trying to stop market corrections, even severe ones, is hardly credible after we saw the market surge 400% with no limits or brakes for the last 11 years. When people lose money, the general speech tilts toward presenting losses as a very importunate and abnormal event or something that shouldn’t go on for too long, however enormous and long-lasting previous gains have been. The wording itself becomes unconvincingly alarming. People have been considering suspending trading altogether «due to the extreme volatility and the risk of disorderly trading».

No one stopped markets on their exponential upside curve

This is no valid excuse to meddle in the affairs of markets. No one stopped markets on their exponential upside curve; this kind of view is only heard when markets go the wrong way. At the extreme, we can fear an interventionist system where authorities would close markets when they go down and open them only when they go up. This would naturally end the very notion of market. But crucially, investors stuck inside would feel trapped, and would rush out even quicker the minute markets would reopen, as they did when hedge funds set up lock-up periods, restricting redemptions back in 2008.

The effects of short selling on a single stock can be huge, but are overstated on the larger market drops, as they represent a small part of trading. Overall, the biggest part of the selling activity during the turmoil has been long selling and not short selling, experts agree. In March of 2020, short positions represented around 900 billion in the U.S., out of a total 10’000 billion worth of stocks traded on U.S. markets, which means no more than 9% of the market.

What is true though, is that short selling is disproportionately rewarded; and it is because it’s extremely risky. Contrary to long bets, short bets have an unlimited loss potential, since the price of an asset can climb to infinity. Shorting is for the tough-minded. In 2007, hedge fund manager John Paulson made history after betting against the subprime market. Mid-2006 already, when nothing was certain, and when UBS – among others – was still accumulating record amounts of subprime paper on its balance sheet, Paulson bet half a billion against the subprime market, buying credit default swaps (CDS, or default insurance) on BBB tranches of dubious asset backed securities (ABS). A year later, he transformed bad paper into gold by making a 690% gain, or 3,7 billion dollars.

Short selling allows for all kinds of bad behavior

Legends left aside, short selling leaves the door open for all kinds of bad behavior. Shorting individual stocks is one thing, but shorting sovereign debt is another. The 2010-2012 euro-crisis episode, during which UK and US hedge funds massively shorted Greek and other European debt, raised big questions about the risk of letting public debt become hostage to such vampiric trading, and be brought to insolvency, exposing whole populations to years of austerity. Even though Greek debt was excessive and mismanaged, shorting propelled its interest rate through the roof.

Regulation of this kind of trading proved inefficient, just like fully regulating OTC derivatives was never possible. But central banks bought so much developed sovereign debt that no funds, even coordinated, could counter them in the following decade. Ultimately, only size matters in trade, and it is truest in short selling.

Another bad practice of short sellers is campaigning to take a stock down, which often includes disinformation and is obviously gross market manipulation. Social networks and the web have rather helped this practice, but the market «noise» has increased so much overall, that these campaigns tend to get diluted and real effect comes at too high a cost.

One thing is certain: In a market that just came out of its longest historical rally, letting short sellers have a brief party is not the worst of abuses.