Food for thought – do fundamental short-sellers shout so hard into the grapevine that it will affect their own bottom line? The answer is obvious from one perspective, and not so obvious from others.
A few weeks ago, the investment firm Hindenburg Research published a report on one of India’s largest conglomerates, the Adani group. It is an icon of India’s economic growth of the last decade or so, having legs in defense, port and airports operation, food, mining, energy, media and construction.
Hindenburg has now accused them of stock manipulation using a network of shell companies, and fraudulent accounting and window-dressing of earnings over decades.
This sparked massive selling in Adani Enterprises and its subsidiary companies. Adani’s stock had cratered in the subsequent days up to 70% at one point, with prices currently hovering approximately 60% lower than levels of the 25th of Jan when the report was released.
Sensationalist and media-buzz generating rhetoric, citing the “largest corporate fraud in history“, has led to wide publicity of this report after Hindenburg took their short position. Because of India’s restrictive trading rules for outside entities, Hindenburg here actually achieved a short bet using US bonds and derivatives.
Now, there are different types of short-selling. There is technical short-selling which for example I practice – using the heightened odds of already down-trending stocks to initiate a short position. The stock is arleady being heavily sold anyway, why not profit from it? But then there is also fundamental short-selling, which usually claims an over-valuation of a still up-trending market or a stock to justify a short bet. Think Michael Burry from the ‘Big Short’ movie/book.
In fundamental short betting, risk is rarely managed or hedged, and shorts are usually initiated in up-trending markets. For every successful short there are hundreds of thousands of short-sellers that capitulate from heavy losses, client redemptions or margin calls they receive when facing rising continued prices that go ‘against their fundamental opinion’.
Hindenburg has in the past undoubtedly done good work in my eyes, asking important questions about the nebulous business dealings of public companies such as Lordstown Motors, Nikola Corp or Clover Health, and ignited the spark for numerous DOJ investigations. A for-profit approach to make the stock market safer – big stamp of approval.
Let’s assume that a short seller genuinely believes their opinion underlying a fundamental short to be true. Pursuing proper channels and “normal” proceedings, for example submitting evidence to law enforcement, information would percolate out over a moderately long time frame, likely negatively affecting the security that the short better is trying to profit from.
However … If there was a way to increase the likelihood of the financial instrument dropping faster to ‘expedite’ the profits gained from such, and to minimize the chance of the stock continuing its uptrend to cause potential loss for a non-hedged position, would this count as manipulation?
A short-seller like Hindenburg, Muddy Waters or Snow Lake will argue that the information was out there for any committed speculator/investor to find and to act on. That may or may not be true, but financial markets do react to information the moment it becomes available.
That means that the information from various short seller reports in the past was not acted on by the majority of large shareholders – whether it was true or not, and whether they were aware of it or not – until the reports were published. Strong market volatility as seen in Adani, Luckin Coffee, Nikola, Lordstown, and other securities that became subject of such reports by large short sellers, was not a result of company fundamentals right at that time – it was a reaction to the publication of the reports.
I definitely do not want to state that short-selling reports are misinformation or misleading by any stretch of the imagination – quite the contrary. They have started a lot of necessary investigations and regulatory action in the relevant circles, for example uncovering the Wirecard or Luckin Coffee fraud schemes.
But until a legal body of the relevant jurisdiction has assessed the information to be of legal consequence, such a report is not the equivalent of a legal indictment or document. Until shown otherwise, it remains merely an opinion expressed, a private speculation – and opinions have the potential to be wrong.
Publishing an opinion to be seen and deemed at least potentially credible by the public widely, without having been shown to be of substance and consequence, can easily become a self-fulfilling prophecy for a short seller.
Whether factually true or false – until proven through the proper channels, the content of short seller reports remains potentially wrong and cannot yet be deemed true information that should be allowed to influence the markets. There is already a need for disclosure of large short selling positions by funds, so there should be equally stricter regulation on the release of such reports that have the possibility of being wrong, as their effect on markets is undeniable.
Food for thought.
