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Weekend reading: Why I give short thrift to calls for a ban on shorting

Weekend reading

Good reads from around the Web.

One of the many reasons I despair of the average private investor is because of their ridiculous attitude towards short-selling (that is, betting that a share will fall in value).

There’s a limited argument that can be made against short-selling in banks at times of financial crisis, because of the potential to cause self-reinforcing bank runs. There may also be arguments against “naked” short-selling, in situations where the survival of a company is precarious and based on the ongoing confidence of its investors.

Otherwise, shorting is a useful part of the market. Besides generally helping prices to stay efficient, shorters can help dampen down speculative manias and also provide more liquidity to the system.

It’s hard to see why short-sellers should be despised as cheaters. For a start they take bigger risks – because shares tend to rise, not fall, over the long-term, but also more importantly because a short-seller’s potential losses are infinite should a share price keep on rising.

Unfortunately, many stock picking active investors seem to fall in love with ‘story stocks’. They despise shorters because they believe bogus bulletin board chatter about shadowy cabals of market makers and hedge funds, and they seem to have little idea of what really drives the long-term value of their investments.

Short of common sense

You can see this in play whenever a high-profile shorter alights on a particularly beloved story stock, which is quite often because they are often the most over-valued.

Nowadays shorters tend to publish their thesis as part of their attempts to unmask the over-valuation, as they see it, at a company.

And that’s when the fun starts.

Almost immediately private investors call “foul!” They question the integrity of the shorter and anyone who gives two minutes to considering the short position, or writing about it. They even start petitions calling for short-selling to be banned.

This is ridiculous. We do not have a situation where an abundance of negative comment is written about companies – quite the opposite.

Besides, if your company is as good as you think it is, then short-sellers should be welcomed for driving down the price.

Buy more! If you’re right about your company, then the earnings will out in the end and you’ll make even more money.

Of course the suspicion must be that all their bluster hides the fact that the anti-shorters don’t really have much confidence or understanding to fall back on.

What they have are glossy and potentially bogus company presentations, big numbers bandied about by over-pushy CEOs, and some blue-sky vision of what would happen to the company’s bottom line if everyone in Eritrea bought its products.

That’s not an investing thesis. That’s a playground popularity contest.

Here’s one they did earlier

Time after time you see popular small-cap story stocks blow-up and the protestations die down.

Not every short call is right – far from it, as I say shorting is even harder than normal active management, because the market will less often bail you out. But a credible short-call allied to a lot of angry private shareholders should probably give you second thoughts about any company you own.

The chaps from Schroders just shared some thoughts on this, in the context of infamous short-seller Gotham City’s move on wi-fi firm Let’s Gowex:

Gotham City [says] it took some eight months of due-diligence work from the moment its eye was first caught by a little-known Spanish wifi provider called Let’s Gowex to the publication on 1 July of a scathing report, among the conclusions of which were “Over 90% of Gowex’s reported revenues do not exist” and “Gowex shares are worth €0.00 per share”.

Gowex’s immediate response was to come out with all guns blazing but, within a matter of days, it had been forced to declare bankruptcy and admit that its chief executive and founder Jenaro García Martín had made up its accounts for the last four years.

Channelling the spirit of its favourite superhero, Gotham commented: “It is not who we are underneath but what we do that defines us.”

As recently as February of this year, Gowex had a market capitalisation of almost €2bn (£1.58bn)  and had seen its share price rise more than 1,000% since the start of 2013 – taking it to the fringes of Spain’s principal IBEX 35 market and making it one of the best-performing shares in the world.

The average professional short-fund manager is to a noisy and angry punter in small cap shares what Superman is to your grandad in tights.

Okay, shorters are not super, nor even heroes, but it is certainly a mismatched battle of investing smarts – and I know who I’d put my money on any day.

Enjoy the sunny calm before the storm!

From the blogs

Making good use of the things that we find…

Passive investing

Active investing

Other articles

Product of the week: The Telegraph has spotted a glitch in the fixed rate mortgage market, which makes the average three-year fix cheaper than an average two- or five-year fix. But note that best buy mortgages can easily beat the averages.

Mainstream media money

Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.1

Passive investing

  • Does it matter if the S&P 500 is active managed? – Swedroe @ ETF.com
  • Index trackers soar but risks remain [Search result]FT
  • Cheapest platforms: An overview – ThisIsMoney

Active investing

  • Investors lose out through poor trade execution [Search result]FT
  • Frontier markets versus emerging markets – ETF.com
  • Are frontier markets overheated? – WSJ

Other stuff worth reading

  • How to successfully slack off at work – BBC News
  • Indeed to work better, work less – The Atlantic
  • No new boom: Houses are already too expensive – ThisIsMoney
  • 5 shopping bargains to bag on holiday – Guardian
  • How HMRC spies on you – Telegraph
  • Don’t wear a suit if you want to appear smart – Economist

Book of the week: Got a Kindle? (If not, why not?) Amazon has a summer sale on, and it’s offering over 500 Kindle books at up to 80% off.

Like these links? Subscribe to get them every week!

  1. Reader Ken notes that: “FT articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”.” []

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{ 16 comments… add one }
  • 1 gadgetmind August 9, 2014, 12:49 pm

    Minor typo: ” They despite shorters” /despite/despise

  • 2 The Investor August 9, 2014, 1:08 pm

    Cheers, fixed now. Though “despite shorters” seems appropriate in some cases too!

  • 3 Willem de Leeuw August 9, 2014, 1:22 pm

    Apologies if I’ve misunderstood a clever headline and for being pedantic but shouldn’t it be, ‘short shrift’?

  • 4 PF August 9, 2014, 1:43 pm

    He must be a Yank, given all the “smarts” and adverbial “likely”.

  • 5 The Investor August 9, 2014, 1:57 pm

    @Willem — Originally I called the article just “short thrift” and it was meant to be a sort of pun, implying you could husband your cash better by paying attention to shorters. But it looked flimsy on Twitter so I expanded it out.

    @PF — I’m here you know. 😉

  • 6 May August 9, 2014, 3:11 pm

    I enjoy watching the short haters on some of the stock message boards. (weird I know…) Going short runs counter to mental models of the investing and the stock market that things go up in value.

  • 7 dearieme August 9, 2014, 4:44 pm

    “@PF — I’m here you know.” Then why did you, like, give up on English, bud?

  • 8 gadgetmind August 9, 2014, 5:00 pm

    On the bright side, that we’re picking holes in your spelling, grammar, etc. means that we’re reading what you write and care enough to at least try to help. In our own way. Sort of.

  • 9 PC August 9, 2014, 10:01 pm

    As a trader in a past life, I couldn’t agree more – I never understood why the popular press sees some kind of moral difference between being long or short

  • 10 Justin @ Root of Good August 10, 2014, 3:09 am

    I can’t say I’ve ever shorted anything, but having the option is nice. Although I probably would lose my shorts. I remember when Apple came out with the latest great thing – the iPad. No one would want a 10″ tablet I thought. Turns out I was crazy and Apple made a ton of money. Good thing I stick with passive index funds! 🙂

    I like those who short though – it improves price discovery in the market. There’s enough risk involved to keep folks honest. And I don’t really care if share prices fluctuate due to shorts given my loooong term perspective on investing! If anything, an artificially low share price due to a short attack could allow the targeted corp to ramp up a share buyback program.

  • 11 gadgetmind August 10, 2014, 9:18 am

    I’ve made a lot of money (deep into six figures) by being very long on one of the most heavily shorted shares in the FTSE. The knowledge that a fair bit of this money has come from the pockets of shorters fills me with happy.

  • 12 dearieme August 10, 2014, 1:13 pm

    “deep into six figures”: £1,000.57. Or perhaps that’s more my world than yours.

  • 13 The Investor August 10, 2014, 4:54 pm

    “@PF — I’m here you know.” Then why did you, like, give up on English, bud?

    I don’t believe language is some static code to be preserved in granite tablets for future generations. Anyone with a nodding acquaintance with linguistics understands that our vocabulary, grammar, and punctuation evolve. Anyone who has seen or read Shakespeare appreciates how far language can move in 400 years. That’s part of the beauty of it.

    That’s not to say anything goes, not at all. But if you think the language we use here on Monevator is not English — or that we haven’t got the smarts to use the word brains instead — then we have a different idea of where the English language is in 2014. 🙂

    Anywhere but Pedant’s Corner for me when it comes to language.

  • 14 dearieme August 11, 2014, 12:30 am

    “we have a different idea of where the English language is in 2014”: it’s in California, of course.

  • 15 Kiat August 11, 2014, 1:38 am

    Short selling give investor the incentive to be a whistle blower, imagine if they did not blow the whistle, how many more main street people will be hurt if the stock price sky rocket and finally come to reality and collapses.

  • 16 M August 11, 2014, 1:38 pm

    I’m not exactly a fan of short-selling. It’s not investing, it’s just gambling. I’d prefer if it was quite limited. It’s pretty dangerous to economies when done on a large scale too (erm, anyone remember what Soros did?!) I don’t really believe it helps prices to stay ‘efficient’ either. What on earth is an ‘efficient’ price? How do you gauge that exactly? And this might sound harsh, but people need to lose money to feel the pain of foolhardy greed sometimes…

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