Jim Chanos: Psychology of short selling

Bailey McCann, Opalesque New York:
Jim Chanos, Founder of Kynikos Associates is a legendary short seller. His market viewpoints are widely followed by investors and managers alike. He was recently interviewed by Greg de Spoelberch for Opalesque TV.

Chanos has been a short seller almost since the beginning of his career. His first short was Baldwin United in 1982. "That got me thinking about the whole idea of whether or not there was a business to be made in fundamentally analyzing short ideas," he says. From this idea he founded Kynikos Associates in 1985 as a hedge fund management company to manage short-only partnerships.

Today, Kynikos has expanded, managing approximately $6bn with $5.5bn in short-only and the remainder in a long/short fund. Both the short-only and long/short programs invest globally.

"One of the things I hear often from people is, well, I do not like to short stocks because they can go up infinitely, but they can only go down to zero. I, of course, always point out that I have seen many more stocks go to zero than go to infinity," Chanos says by way of explaining why he prefers to short. One of his biggest current targets is China. Chanos has been outspoken on his view that China’s bad debts outpace those of Greece and Spain.

According to Chanos’ research, the current high level of infrastructure build up happening in China is largely credit financed and, despite a growing economy, he feels as though the country will not in the end, be able to cover all of these costs. "I have no doubt that if the Chinese government says that they are forecasting 7.5% growth this year no matter what is happening is with the real economy, they will print 7.5% or better, but I do not necessarily believe that, that reflects reality," he says.

"China, to us, started with an examination of the global iron ore companies and really has now morphed into a reasonably diverse portfolio of property companies, developers, construction companies, cement companies, steel companies, as well as the original iron ore miners in Australia and Brazil. Now, the Chinese banks, because as we did more and more work it became very apparent to us that the Chinese banks are the nexus through which all this credit-driven investment is flowing."

He notes that he is broadly short because the overall picture at both the macro and micro levels looks incredibly dire. "I think the macro story is due to bad credit and credit extension that makes Greece and Spain and the US look like child’s play. When you get to the micro the individual companies they look even worse. The accounting is horrible, they all seem to have negative cash flow, they all seem to have uncollectible receivables, and they all seem to not earn their cost of capital."

Chanos is widely credited with seeing and being correct about short opportunities early. He shorted Enron sooner than many others and also started shorting the US housing bubble years before the crisis. Now all that may change as a result of regulation of the short selling space but, he notes that financial regulators who seek to limit this practice may be causing more problems than they intend.

He argues that short selling bans actually exacerbated the 2008 crisis as most funds were covering their shorts, and it was the late-to-the-party banks trying to hedge counterparty risk that ended up getting caught in regulators crosshairs. "When that froze, when the inability to short froze up, is when the funding crisis hit. {…} We pointed this out to the European regulators in the summer of last year when they were rumored to be considering short bans, and we said you are going to make financing markets more difficult the minute you put the ban on, and sure enough that is exactly what happened," he says.

1 comment:

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