Short-sellers faced a new reality the last few weeks as retail squeezes became a threat they could no longer ignore.
A saying sometimes attributed to the famous economist John Maynard Keynes warns investors, “Markets can remain irrational longer than you can remain solvent.” If big investors needed a reminder of that idea, they got one in the past few weeks as hedge funds were squeezed out of short positions in the likes of GameStop.
For the likes of legendary short-seller Carson Block of Muddy Waters Research, there are lessons to be learned as he looks for his next target.
“This is something that we’re going to be very attuned to, that we could become victims of a squeeze. So we have to be nimble,” Block told Insider in an exclusive interview. “It’s all about risk management. There’s a potentially lethal risk out there from the business perspective for us, and we have to respect that.”
‘Fundamentals are mattering less’
Block says it makes a big difference that so much money on Wall Street now swings based on technical trades and levels instead of fundamentals. Investing based on his firm’s research is much more complicated.
“Fundamentals are mattering less, and especially with the massive amounts of stimulus that has been pumped into markets as a result of COVID, it’s really more about flows and technicals,” he said. “If people see these technical dynamics like, ‘well it’s heavily shorted, the float isn’t that big, and call option pricing isn’t that expensive’ … there are traders who might jam it up on us.”
That adds more difficulty to an already-difficult landscape. Block says his firm’s short position in Chinese education technology company GSX Techedu was the target of a short squeeze last year. He’d bet the stock would fall, but it went from the low 30s over the summer to more than $100 by October. It’s currently worth about $90 per share.
So if institutional investors targeted his short position, as he suspects, their approach worked well. He says that’s because they had a strong understanding of the stock’s technical levels as opposed to his more fundamentally-based approach. He’s not abandoning that, but he’s been forced to adjust.
“It’s even more treacherous being a short-seller than we saw on December 31st of last year,” he said. “Between 2009 and December 31st of 2020, almost all short-focused fund managers have gone out of business.”
That trend continued as r/wallstreetbets became global news. In late January, a few days before Block spoke with Insider, investor Andrew Left said that his firm Citron Research would abandon short selling after the explosion in GameStop shares, which hit Citron hard. Left also faced severe criticism and said his family was harassed.
Block acknowledged that it’s “frustrating” that his firm’s research might not matter in the short term the way it might have in the past. But he has no choice but to adjust for it.
“I think you probably have to be an activist to succeed here, but I think you also have to know that there’s no medal for valor here,” he said. “You publish your work, you have a sized position from a risk management perspective, and be prepared to get the hell out of the way if the mob is coming for you. Then you can re-short it.”
Block’s short candidates
Block says he’s currently shorting French computer and network support company Solutions 30 and Chinese social media company Joyy. While he’s absorbed losses in bets against GSX and medical imaging company Nano-X as their prices rose, Block says he’s trying to treat the price spikes as opportunities.
If he thinks a stock is overpriced at $30, it’s an even bigger opportunity at $90 with so much farther to fall.
“In a way, I hope this turns out to be a really nice gift that the squeeze has given us with GSX, because we’ve been scaling up our position the past couple of days,” he said. “Fundamentals in the near term are not mattering. I think that fundamentals over the long-term are still going to matter.”
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