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The Power of Negative Thinking:
A Short Sellers Perspective
18 May 2010Hosted by CFA Institute
www.cfainstitute.org
James S. ChanosFounder and Managing Partner
Kynikos Associates
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Short Selling Is:
Essential Not the opposite of going long
A large alpha-creating strategy Important to theoretical finance Non- regulatory watchdog functions
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Short Sellings Role
Many commercial enterprises engage in shortselling everyday!
Essential for hedging, market-makers, etc. Investors benefit market quality improves Who wears the white hats? (Enron, Tyco,
subprime, Lehman, etc.)
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Financial Detectives, NotArchaeologists
Focus on companies fundamentals relative to marketmisperceptions, identifying overvalued stocks that willunderperform
Aid price discovery broadening range of views forinvestors to consider, a counterweight to exuberance
Improve market quality lowers costs throughnarrower spreads, deepens liquidity, and helps alignsecurities prices with fundamental values
Unearth corporate financial fraud and malfeasance
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The Constraints
Must borrow shares; possibly pay rebate Regulatory rules
Concept of negative reinforcement Outright bans temporary or otherwise
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Blame Game
Regulators and politiciansalways need someone toblame when people losemoney. The shorts, along
with fair value accountingand the irresponsiblemedia, were easy targetsfor those seekingscapegoats for a half-decade of bad banking.
Financial Times , September 30, 2008
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Case Study: 1932 Ban
Two and a half years after BlackTuesday, regulators restrictedshort sales in an attempt to endthe stock market crash
Despite this, the market went onto lose another 50% over thenext five months
As Benjamin Anderson wrote inEconomics and the PublicWelfare , the ban led to share
declines that "were moreextreme" plus the subsequent"rallies were far feebler thanwould otherwise have been thecase"
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2008 Short Selling Bans
Transaction costs rose Liquidity dried up
Failed To Support Stock Prices FundamentalsRule!
Greater volatility
True price discoverysuffered
Short-selling ban goes into effect
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The Theory
Essential to CAPM William Sharpe s 1990 Nobel Prize acceptance
speech The 3Com/Palm episode
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Short Selling: The Research Process
Numbers are obfuscated No access to management Sell-side hates you
The Bad News
The Good News Numbers are obfuscated
No access to management Sell-side hates you
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Short Selling: Sources of Ideas
Experience Third-party research Screens, etc. Other money managers (not necessarily other
short-sellers) Our partners/investors Experience
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Short Selling: Some Recurring Themes
Booms that go bust Consumer fads
Technological obsolescence Structurally flawed accounting Selling $1.00 for $2.00
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Case Study: Enron ForgottenLessons?
The need for a standards-based accounting system not a rules-based one
Mark-to-market accountingwas not the problem; mark-to-model was
Off-balance-sheet deals and
entities are off the balancesheet for a reason
Rating agency system breaksdown when needed most;rely on it at your own peril
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Case Study: China Syndrome TheSequel
Not a call for impendingcrash
Classic pockets ofoverheating,overindulgence
The Scylla of overcapacityand the Charybdis ofinflation
Credit-driven propertybubble
Global implications