Finweek English Edition

Short-sellers are again at the short end

Short-sellers have hoped that a tighter US monetary policy would pull back equity shares, but to no avail. Why is a long view the better option for now?

- By Maarten Mittner Maarten Mittner is a registered tax practition­er, freelance financial journalist and a markets expert.

the latest signals from the US Federal Reserve have reassured equity markets that the central bank will not act rashly with its tapering objectives. Disappoint­ing US job creation numbers has resulted in further caution, while the Delta variant of the coronaviru­s could cause further disruption over the Northern winter. The Fed’s message was that monthly bond purchases may be reduced at year-end, but it will be gradual and must not be seen as indicative of any imminent hiking of interest rates. Large tech companies’ stocks surged on the developmen­t, presenting another blow to short-sellers, who hoped that a tighter monetary policy would pull back equity shares, mostly Big Tech, from their present highs.

Apple reached new heights, increasing its market cap to $2.6tr, while Microsoft, Amazon and Tesla all gained ground on the pronouncem­ents from Fed chair Jerome Powell.

Short-selling is a way of making money when stocks appear to be overvalued and could be due for a downward correction. Some analysts regard Tesla as way too expensive, as its intrinsic value is calculated at about $150 per share. But it is now trading at upwards of $700. Should it dip and fall to a value more closely correlated with its intrinsic value, short-sellers are set to make big money by buying shares at cheaper levels, like buying a house at R1m that previously cost R5m.

Hereby an overvalued share is borrowed at say $700 and then immediatel­y sold, usually partially, to drive the price lower. When the share hits a lower level, say $200, the shares are bought back at the lower price and returned to the shares’ owner, resulting in a $500 per share profit made, minus any margin payments that had to be settled.

But if Tesla was bought at $500 per share, hoping it would go down to $200, and it spiked to the present $700, an investor would be out of pocket, as $200 per share more is now payable on the position that was initially bought, together with margin costs.

This is precisely what has been happening with shortselle­rs having positions on Tesla. The share stubbornly resists to rerate lower because demand is still high, despite a strong case for an obvious overvaluat­ion. Tesla until recently traded at a price-to-earnings ratio of 1 000 times.

It is not only Tesla. Many investors have large short-selling positions against Big Tech stocks because of last year’s strong run. But the envisaged correction remains elusive, and high valuations may remain the reality if the Fed is wedded to an easy monetary policy stance.

Short positions against well-known investor guru Cathie Wood’s tech-heavy Ark Investment Funds have more than doubled in anticipati­on of some correction. The Ark Tech Innovation Fund was a star performer in 2020, rocketing over 150%.

Recently there has been some sharp outflows from Ark funds. But it is probably more related to the squaring of margin positions by short-sellers than any real negative sentiment as it has become very expensive for shortselle­rs to hold onto these shares.

Short-selling is not a one-way bet. In fact, shortselli­ng successes are very rare. Capitec on the local market is a good example.

In 2018 it came under severe selling pressure following a negative analyst report, falling below R1 000 per share. Since then, short-sellers have been burnt as the share gained to R1 800 apiece, with compound returns of over 200% over the past five years. Its market cap is now on par with that of Standard Bank, Africa’s largest lender by assets. With hindsight since last year, it would have been far preferable for market players to take long positions on tech stocks. That is, betting that a share will go up and not down. The exception being Chinese tech stocks, which have all suffered due to regulatory steps from the Chinese authoritie­s. It might just be a blip.

Short-selling is controvers­ial. It may even be illegal in some respects, as shares are meant to represent capital growth. But the proponents say it is positive for any market as it increases liquidity.

Few sectors at present appear to offer clear opportunit­ies for short-sellers. Mining stocks remain undervalue­d, with heavyweigh­ts Sibanye-Stillwater and Anglo American Platinum still rated as buys. Long positions may be more profitable, taking cognisance of expected growth in the Chinese economy and continued easy monetary policies.

Tech stocks have moderately rerated from recent highs, also mitigating against extreme short positions. Value stocks may also still have a way to go before becoming overvalued, thereby offering clearer longbuying opportunit­ies.

Those that are prepared to take the risks can win handsomely with short positions. The key is to take the general overall market direction and macroecono­mic factors into account. It remains very risky. Short of a general market catastroph­e, a long view is the winner for now. ■ editorial@finweek.co.za

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