Zak Mir on Drawing The Short Straw

I suppose the mutations of the financial markets are such that at the end of every year there are plenty of new aspects that even the most seasoned of commentators, investors and traders will have learned. There are also things that we are reminded of. For instance, for small to mid sized companies to get a decent sized fund manager or pension fund can be a transformational event, and one worth celebrating. It can change your PLC from being stuck in the backwaters of the FTSE Small Caps, to being a contender for the FTSE 250 and much more. However, this process is not a one way street.

There are plenty of companies who rather than ticking boxes simply raise red flags, just the type of flags that a hedge fund or bear trader may be ready to pounce on to turn a profit via a bet on the short side.

This is of course fine, given the way that it takes two to make a market. It is also the case that just as you can lose your shirt buying a stock at say 100p and seeing it go down to 5p, you can equally lose your shirt and perhaps your trousers as well, by shorting a stock at say 5p and seeing it rise to 100p. A good example of such failed shorts in the recent past would have been Dixons when it fell below 10p at the beginning of 2012, and Thomas Cook (TCG) when it fell sub 10p at the end of 2011. Both stocks have risen many fold since then, and it should therefore be remembered that bears would have been hit very hard on both situations.

Of course, this year’s big shorting “victory” to date has been Quindell (QPP) as the insurance sector outsourcer did not seem to be able to put a foot right against the ravages of hedge fund Tiger Global and the blogosphere. However, if H2 2014 was the Bear Party, it should be remembered that from May 2013 to February 2014 the stock rallied from 81p to 668p. All of this was despite the alleged red flags from “forensic accounting” and other mystical methods. The straw that broke the camel’s back was the Gotham City Research piece on Quindell – after which the stock plunged, and the rest is history.

However, what we may have collectively learned from the Quindell episode is not just that damning research (paid for or otherwise) can bring down vulnerable companies. It is the way that such incidents tell us when hedge funds are massively short, this is the sell signal we should follow.

Put even more simply, look at the stocks on the market at the moment where there is the most short interest.

If the list includes companies of the gravitas of Odey Asset Management or Landsdowne Partners are short, you would have to be pretty brave to go long. It would be the equivalent of shorting a stock when you hear that Goldman Sachs has just brought out a Conviction Buy note on a company.

For instance, as of recent days it has been openly declared that multi billion Dollar hedge fund GMT Capital is short of Ocado (OCDO), or Nanoco (NANO). While Landsdowne Partners is short of Morrisons (MRW) and Tullow Oil (TLW). This rather puts me off looking on the bright side of any of these companies. Of course, the hedge funds could be wrong or may have lightened their bear positions in the interim, but the principal still stands.

In fact, my point is perhaps a little more esoteric than you may have gleaned from the article so far. One of the big problems in the post financial periods has been liquidity, especially from the second liners down to the small caps and AIM. The lesson learned this year is that apart from following what the “big” players do, both long and short, there is another thing to learn.

It is that in relatively light trading conditions and lightly traded companies a raid on the bear side whether justified or not can end up being a self fulfilling prophecy. While there may have been some correct reasons for the massive share price declines in the laggards of 2014, it is not difficult to imagine how Chinese Whispers and concerted shorting could not have brought down the odd company or two, with or without due cause.

As a post script we have just learned that Roble SL, Quindell’s nemesis, has reduced its short position to 1.84%. At the peak this figure was 5%. Perhaps things are not quite so bad at Quindell, or maybe enough money has been made on the short side? It would be interesting to know the answer. Either way, what we have seen from the examples where hedge funds have been short for extended periods is that they do not usually go for total destruction of their prey. Apparently, covering a short on a suspended stock is a messy business…