US stock shorters are losing ground by day, and the “big bears” are facing a “darkest hour”

The Zhitong Finance App learned that after being hit by many parties, US stock bears are retreating. This is due to the gravitational bull market in US stocks, lingering regulatory threats, and the continuous rise of stocks such as game stations that are being arbitrarily squeezed by the intraday trading force.

This is probably a bad time for Wall Street. Well-known bears have been hit one after another. Jim Chanos withdrew due to failed financing, Carson Block (Carson Block)'s Muddy Water Capital launched the first one-way long fund, and Andrew Left (Andrew Left), founder of Citron Research, referred to his type as an “endangered breed.”

According to Goldman Sachs, bears for typical stocks in the S&P 500 index are hovering at their lowest level in more than 20 years. According to HFR data, during a period when the overall size of stock hedge funds nearly tripled, the assets of short funds have declined from US$7.8 billion in 2008 to US$4.6 billion. The radical strategy advocated by well-known bears Bullock and Lift, to look for company flaws and bet on them before going public, started at the slowest pace in a decade in 2022, compared to a slight increase last year.

In this context, a series of well-known bears have curtailed their shorting activities, and some have withdrawn from the industry, including the most famous investors. Jim Chanos (Jim Chanos), a legendary short maker known for predicting the collapse of Enron Corp. (Enron Corp.), said, “Our fund business is shrinking, and people just don't want to invest. Investors (mostly institutional investors) have given up on the fact that shorting has excessive returns.”

Chanos announced at the end of last year that after almost 40 years, he would turn his hedge fund into a family office. Investors lacked interest in bearish strategies and the fund “was unable to pay management fees,” he said. Assets fell from over $6 billion in 2008 to less than $200 million.

As for bears, a divided corner of the investment world, some people praised it for exposing corporate scandals involving companies such as Wirecard, while others slandered it for harming investors' interests and increasing market turmoil. HFR's partial hedge fund index had 54 constituent stocks in 2008, but after years of losses and capital outflows due to multiple strategies, the number of constituent stocks of the index has declined sharply to 14.

The goal of short sellers is to buy back borrowed (and then sold) shares at a lower price, return them to lenders, and preserve profits. But in a market where stocks seem to only rise or fall, this may be difficult to do. Over the past ten years, the market value of the S&P 500 has surged by about $30 trillion, and has more than doubled in size. This was first driven by the era of ultra-low borrowing costs, and recently by the fanaticism fueled by artificial intelligence.

Nicolaos Panigirtzoglou (Nikolaos Panigirtzoglou), a strategist at J.P. Morgan Chase, believes that this “massive expansion” in the stock market makes short positions unsustainable. This doesn't necessarily mean that bears are wrong, but the upward trend in the market means that any bearish arguments will take longer to materialize, and at the same time, bears must pay borrowing fees for the stocks they sell. No wonder that, according to Goldman Sachs's estimates, the S&P 500's positive position is currently around 1.7%, which is only slightly above the 2001 low and lower than the long-term average of all major stock industries.

But the rise in the market is just one in a series of challenges. In 2021, the US Department of Justice and the Securities and Exchange Commission (SEC) discovered that many aggressive shorters were being investigated for allegedly manipulating the market. There are currently no charges, but the US SEC also finalized relevant regulations last year requiring hedge funds and other large investors to report total short positions in certain stocks on a monthly basis, thus strengthening scrutiny of this business.

This is part of a global regulatory tightening model, and short selling has also been restricted in countries such as China and South Korea. It also officially expresses the general suspicion that traders are trying to profit from the decline, who have long drawn anger from the companies they are targeting, investors in these stocks, and the financial community. The former president of the New York Stock Exchange even described them as “disgusting” and “non-American.”

“This is a terrible business,” said Left, the founder of Citron Research involved in the Department of Justice's investigation. You're just putting yourself in the midst of ongoing lawsuits by the company and government. Why would I do that?”

Left doesn't think he did anything wrong, but the investigation has had no results so far. At the same time, he was also one of the bears that suffered heavy losses during the 2021 pandemic. At the time, retail traders gathered on online forums to squeeze bearish companies by bidding for shares of companies such as GameStop and AMC Cinemas (AMC.US), the most famous of which was Gabe Plotkin (Gabe Plotkin)'s Melvin Capital Management (Melvin Capital Management).

Despite the heavy losses, the shorters became bad guys in this storm, even though they are used to this role for a long time. However, it must be said that this incident brought a new round of negative attention to the industry.

Chanos scoffed at the whole incident. He said, “It's absolutely crazy for retail investors to buy these worthless stocks and then blame the short sellers for the problem. The bears are the only ones being crushed by the game station phenomenon.”

Over the past two months, retail traders have once again shown their strength, and the stock prices of several popular stocks, including GameStop, have once again soared. Overall bearish investors may have escaped the worst. Data from analysis firm S3 Partners shows that after the events of 2021, shorting interest in the video game retailer never rebounded, but this is also a reminder of the danger. In less than a month, Goldman Sachs Hedge Fund's most shorted basket of stocks went from losing nearly 10% year to date to rising more than 13%.

Lift said these “meme stocks” dramatically demonstrated the “gamification” of the market, and this “gamification” has destroyed the entire short selling industry. He said that in the midst of some recent turmoil, he is once again betting on game stops, but only for a small position and for “fun.”

“You can't go short on a large scale,” Lift said. “People are now aware that after the GameStop incident, stock prices may rise for many different reasons.”

All of this helps curb aggressive shorters like him. According to Diligent Market Intelligence, compared with 280 events in 2015, there were only 110 events in 2023.

The downside of short selling is theoretically limitless. Industry insiders say that it is becoming increasingly difficult to attract new cash for high-risk bearish methods, whether it is an aggressive company or simply a short fund. Russell Clark closed his fund at the end of 2021 after betting on the stock market for more than a decade. His RC Global Fund bets on Chinese and American tech companies, whose assets have dropped to $200 million from around $1.7 billion six years ago. Asian holdings paid off, but rivalry with US large-cap stocks took a heavy toll on performance.

Clark said, “If large allocators can make money by going long on the S&P 500 index, why should they take career risks to allocate hedge funds that prefer bears? Before we actually see demand for hedge funds, we really need to see changes in the dynamics of leading stocks.”

Chanos said that the current downturn is part of a cycle similar to what happened when the internet bubble formed. The problem is that this slump is likely to last a long time, and he thinks this time it's been going on for 15 years. During this period, Goldman Sachs's basket of bearish stocks had an average annual increase of more than 9%, and HFR's bias index lost an average of more than 10% per year.

Chanos said, “The longer the cycle, the more questionable and unpopular short selling seems to be, but this is usually on the eve of huge profits.”

According to this view, a continuously rising market will not only create overvalued companies that will cause shorters to end up enjoying themselves, but will also cover up underperforming, and sometimes fraudulent, companies. This may be especially true when short selling is at a low point, as bearish activity has been shown to curb bad business behavior and keep the prices of companies with questionable financial statements under control.

Chanos believes that big investors are missing out on “an excellent opportunity” by abandoning short selling. Clark has hinted that when he decides the conditions are right, he may consider returning to his old business. In the past seven months, even Left has published at least two reports, but he said he only plans to release reports on rare occasions, and only for what he sees as non-“ consumer-driven” companies.

Meanwhile, Glen Kacher (Glen Kacher)'s Light Street Capital Management persisted in the business despite heavy losses in the initial Game Station incident. He's been using more custom baskets to get a wider range of bearish bets, and since this year, his shorts, along with long positions including on tech giants such as Nvidia (NVDA.US), have helped boost this hedge fund's returns.

Katcher said, “A large part of the market is passive funds. They don't analyze what's happening, which creates opportunities for bears.”

S3 said that since this year, there are some signs that bearish sentiment has rebounded from a historically low level, and the US has increased by 76 billion US dollars, about half of which is new shorting behavior. Statistics from data tracking company Breakout Point show that by April, 47 new short trades will be added in 2024. If this rate is maintained, it is expected that 150 new short trades will be added by the end of the year, an increase of 15% over 2023. The company's founder, Ivan Cosovic (Ivan Cosovic), believes that SPAC and ESG-focused investments all provide “rare opportunities” for aggressive shorters.

However, even though global central bankers have raised interest rates to levels not seen in decades, the stock market is still generally higher, making it difficult for bearish bets to last too long. Goldman Sachs Group said that most of the current short bets of hedge funds target indices through ETFs and futures, rather than individual stocks. These are more like hedging tools than inefficient bets on the direction of the market or the inefficiency of a single stock.

Meanwhile, according to Acadian Asset Management (Acadian Asset Management) data, borrowing stocks in some corners of the market has become very expensive, which poses another disadvantage for shorters.

Some bearish investors are looking for other ways to express their views. Bullock, founder of Muddy Waters Capital LLC (Muddy Waters Capital LLC), said he believes Vietnam is a potential beneficiary of capital reflows. The reasons behind the company's newly established long-term fund targeting Vietnamese stocks include believing that some regions are “uninvestable.”

For Fahmi Quadir (Fahmi Quadir), the founder of Safkhet Capital, the key to survival or even development for shorters is to find a strategy to profit even when the general environment is not favorable to them. She's already had some notable wins, including betting on pharmaceutical company Valeant Pharmaceuticals when it was close to its peak in 2015 and betting on Wirecard before it crashed in 2020.

Quadir said, “You must be able to adapt to the market environment, or at least try to eliminate the impact of the market environment on your investment portfolio. There's never a good time to go short.”