My style of short selling is very different to typical short sellers - at it simplest I see stocks as under-priced currency options if you think a currency is likely. For me, shorting weak dollar trades in 2011 made loads of sense. The problem for me is that unlike previous cycles, the dollar has stayed “strong” from ten years now. This change in currency behaviour is why I don’t run a fund anymore.

Despite me having a very different style of short selling, I still remain in touch with a few short sellers (like the cockroaches they refuse to die even after a 15 year bull market). I will not mention their names, unless you are an allocator looking for short exposure, then drop me a line. One of them mentioned a stock that I don’t remember looking at, but rang a bell - SMCI US - Super Micro Computer Inc. A quick look at the chart made me think - wow this sucker is volatile.

Straight off the bat, I noticed this stock had a high short interest at 17.5% of the float. That’s quite high, and makes short selling very tricky. One of the first problems with high short interest is that a long seller can not sell until they have recalled their borrow. That is from a flow basis, the short seller needs to be squeezed, before the owner of a stock sells. Sometimes a stock with high short interest can still be liquid, but if we have seen a recent spike in short interest then it is best avoided. Sadly, this is the case with SMCI - where short interest has cone from 50m shares at the start of the year to 100m now (see bottom chart).

I started looking at SMCI US, and then I remembered why it rang a bell. It was accused of putting spyware into Apple phones a few years ago. I would have considered US tech restrictions on semiconductors, plus these claims of spying for the Chinese government as making SMCI a dead business.

But even back then, SMCI US was a difficult short. It recovered quite quickly from its sell off in 2018 - which should have been a warning to short sellers that something else was at play. That something else was that it acts a distributor for Nvidia chips - which has meant that business has done very well. Shorting this stock in 2018 on the back of trade wars, spying accusations, or even just fears of a recession would have made sense - but was totally wrong. Short selling sucks.

Another more straightforward short selling disaster is Carvana. This was a stock that did very well during the Covid boom, but then collapsed as interest rates spiked.

It looked like a business that was going bust, so short sellers piled in. At its peak in 2021, short interest was only 10m shares, but reached a high of 50m shares in 2023, right at the lows. Carvana has returned to sales growth, and is now profitable. The shares are up 400% this year.

I add these to stocks to my file of short selling graveyards. They join such stocks as China Evergrande, a now bankrupt company, which was the biggest short in China in 2016. After the first Trump election, China choose to stimulate, and Evergrande short sellers were annihilated.

If you still want to short sell despite the above (and other stocks like GME or AMC, or even the biggest short in the US for many year - Tesla), then I offer you a piece of advice. Never short popular shorts, and always try to short a stock that is already falling. Good luck out there.

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About a month ago, I wondered if it was time to short semis. Being long semis has been an amazing trade. The Philadelphia Semiconductor Index (SOX) has been a 10 bagger over 10 years.

I have been looking at semis as a short for a long time as a play on weakening Chinese demand, but even though China makes up 50% of end sales in the semiconductor market, Chinese weakness has not been evident in semiconductors, particularly in comparison to industrial commodities. So what has driven the performance of SOX?

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The “secret” in fund management is to find a bull market, and ride it all the way up. If there is anything special about me, is that I am very happy to short the bull market I rode all the way up, once I think it is done. I did that with mining stocks and emerging markets, and now I am doing it with bonds. I like it as it is working smarter rather than harder. The really great thing about it is that once I find a bull market, I know that I will make even more money when I get around to shorting it (raising money when you are running net short and right is much easier than raising money when you are right and net long - fact).

The best bull market is finding a story that is so big, that the mind just can’t understand it. The best real example I know off was with iron ore in 2002. A buddy of mine as working at an Australian mining company, and told me that the strategy team had asked the economic team to forecast Chinese iron ore demand. At the time, China had recently overtaken Japan as the biggest steel producing nation. Data from that time is below.

China had 10 times Japan’s population, 25 times Korea’s population and 65 times Taiwan’s population. So the economics department came back with an estimate that Chinese steel production would grow 8 times, and would need to import more iron ore that was currently being produced globally. The feedback was that this was impossible, and they needed to tone down their numbers. Broadly speaking, the economists they were correct, but the business people were spooked by the investment that this implied, so ignored the forecast.

Pure play iron stocks like Vale in Brazil did phenomenally well, 20 baggers from 2002 to 2007. But why did Vale peak in 2007 if Chinese steel production has risen another 50% from that point?

The answer to that question is capital expenditure. As no one believed Chinese demand could rise that much, capex budgets were kept under control until 2006 or so, and then exploded higher. This not only reduced cashflow to firms, it also eventually raised supply and reduced prices.

Semiconductors have been even better than mining as an investment. The Philadelphia Semiconductor Index is up 10 times in the last 10 years.

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I have said that the market price is truth. The problem with the market being the truth, is sometimes it tell you different things. I recently discussed the issues with Domino’s where its franchisees were suffering, while the parent company stock was surging. This possibly suggests that it has not raised prices with costs, to drive market share, which is causing margins at franchisees to fall. I like this analysis, and would suggest that restaurant businesses that don’t franchise should be clobbered. This has been the case for some chains for awhile. The Restaurant Group in the UK, which includes the Wagamama brand, fell more than 90% before being acquired by Apollo last year.

Recently, Starbucks reported a fall in revenue, and the stock fell to levels first seen in 2018.

Starbucks does not franchise to the same degree as McDonalds or Dominos. That is it is much more open to margin squeeze from rising costs.

So this would suggest that the margin squeeze is on, and would explain why we have seen a number of deals by franchisors to buyout franchisees. Better to keep these stores running, than have the franchisees go bankrupt. The problem with this analysis is that 100% company owned fast food chain, Chipotle, announced fantastic numbers. Stock is up 37% this year, and has a market cap that is greater than Starbucks now. The market is asking me to believe that people are ditching their frappuccinos, but sticking with their burritos?

What is odd, Tim Horton’s, a Canadian based coffee brand which is owned by Restaurant Brands International, reported no slowdown.

When I go through all the various listed restaurant chains, there is no consistent message. All reporting raising prices, but only some report falling volumes. Starbucks is one of those brands. My problem is that after growing up in Australia, I find Starbucks coffee fairly pointless. I never drink it, so I can’t tell if it has suddenly deteriorated. One thing I have noticed about Starbucks, is that it does badly whenever Howard Schultz is not in charge. This points to two possible reasons for Starbuck’s recent weakness. The first is Howard Schultz is a genius, and in the uber competitive world of coffee shops, without Schultz, Starbucks just become a bit mid. The second option is that restaurant brands have a life cycle. They invest to make the shops look great, and have a great menu, and once sales picks up they make great money for a while, but then the cycle turns again, and sales drops, and investment has to rise, and the stock does poorly. Howard probably knows this, and chooses to step down just before the down cycle hits to let some other shmuck take the hit. Current CEO, Laxman Narasinham was appointed in April of 2023, not far off the peak. Note Schultz returned at CEO in 2008, at a low ebb in the stock after being retired for many years. These two reasons are not mutually exclusive.

What I was hoping to find with Starbucks was the beginning of the end of the financial engineering of fast food chains. That problems with the franchisee model were beginning to exert themselves, and stocks like McDonalds would be great shorting opportunities.

That may end up being the case, but so far the Starbucks problems look to be just Starbucks problems. Is the real problem is that USD 5 for Caffe Latte when you can make it using Nespresso equipment at your home or office has just proved to much? Or working from home hurts Starbucks more than other brands? Or maybe its exposure to the China market has become a problem. Yum China (KFC China operations) has been very poor. However, China is only 8% of sales for Starbucks.

I don’t know what is exactly wrong with Starbucks - but something is definitely going wrong. I would be cautious on the stock, unless we suddenly see Howard Schultz return as CEO.

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Domino’s Pizza is one of the best performing stocks in the US over the last 15 years, and is up 75% from the lows in 2023.

Dominos is a truly multinational business. 66% of its stores and 51% of its revenue is generated outside of the US.

Outside of the US, Domino’s runs a 100% franchised model, through what it calls a master franchise system. There are 46 master franchisee of which are 7 are listed.

What is unusual is that DPZ US, the parent company is close to all time highs, but Jubilant FoodWorks is back at USD levels first seen in 2020.

The Australian listed Domino’s is also the master franchisee for most of Europe and Asia, excluding India and China. As can be seen below, they are big in Australia, New Zealand and Netherlands, and looking to grow in Japan Germany and France.

The Australian listed Domino’s master franchisee is back at level seen 10 years ago in US dollar terms.

The problem for the Australian listed company is that net profits have collapsed in recent years.

The collapse in net profits have come from write down of assets.

Looking at the parent company share prices performance, this makes the weakness of the Australian listed company a bit hard to understand. However, looking at the half year presentation, there are some worrying metrics. The biggest one is that profitability of the franchisee is falling.

So here is where it gets weird. The US market, which is the most penetrated and theoretically competitive market, is driving the share prices of DPZ US, where as the growth markets of underpenetrated Asia and Europe, and growth markets of China and India show real problems, with franchise profitability falling. Logically, DPZ should be a no-brainer short, but I would have thought this 75% ago. Here is where you have to accept the “truth” or market pricing. Domino’s Australia has seen its share price fall with earnings estimates.

While the US Dominos (DPZ US) inflected higher as earning inflected higher. You could argue about the size of the rally in DPZ - but stocks follow earnings, and you should never short stocks with rising earnings.

Close competitor, Papa Johns, is struggling with a share price at levels first seen 10 years ago.

Intriguingly, Starbucks, which is still mainly a US focused chain, has falling earnings.

After going through all this, I am left with a quandary. If I look at the share price of Domino’s Australia, Papa Johns, Jubilant Foodworks, and Starbucks, I would come to the conclusion that fast food chains are struggling. But then Domino’s suggests that the US business is fine, and the stock market rewards it with a 75% surge in value. Do I short Dominos US? Do I buy the other listed Dominos companies? Do I just go with momentum, and buy Dominos and short Papa Johns and Starbucks? When I have shorted before, I have looked for a consistent message from the market - in this case I am looking for a sign that the fast food industry is turning bad. Logically I can see it - but the performance of Dominos makes me nervous to short. I will investigate further, but here is a worked example of the problem with short selling at the moment.

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It seems to me, most fund managers want to short “financial engineering”. To be fair that worked in 2007/8, but when fund managers think about shorting “financial engineering” today, they are probably thinking about private equity. This has been a tough short as I noted recently. Even with 5% interest rates, Blackstone is still raising assets.

The real problem with shorting financial engineering is that there is still no sign of rising unemployment. Excluding the Covid spike, US initial jobless claims are still running at 50 year lows. And government policy still seem intent on keeping employment at full levels.

I have been arguing that the move in GLD/TLT is indicative of a pro-labour change in the world. That move has accelerated in the last month or so. So rather than focusing on shorts that require asset prices to fall, lets focus on shorts that suffer from rising labour costs.

I have looked at fast food chains as shorts before, but recent developments have made we want to take another look.

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I have been bearish on Apartment REITS for some time, so was surprised to see Blackstone has bought Apartment Income REIT Corp (AIRC US) for a 25% premium. Even with the M&A premium, AIRC investors have not done that well from listing, massively underperforming the market.

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If you miss “seeing” me talk - I recently did an interview with Stephen Hsu here.

I really like the pro-labour theory of markets. It has some good explanatory power, and lead to a nice trade - long GLD/short TLT, which I still like.

But there have been some big problems with it, that have lead to a sub-par portfolio construction.

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A typical fund manager or analyst does not want to focus on or care about politics. What they really want to believe is that there is some system in place, that is above and beyond politics. I certainly was the same. But my last great short before closing my fund, was entirely based on catching changing policies. As detailed in my note (Short Selling Sucks - Sino Stock Series), in 2021 the Chinese government called in Chinese internet companies to have a chat about how they were running their businesses. I thought this sounded bad, so scoured the internet to find out which companies had been called in. Eventually I found this:

Which was pretty much the entire listed Chinese internet sector. The performance of the this sector was pretty well captures by KWEB US - A China Internet ETF.

While this short was satisfying, it opened my eyes to the fact that everything is political these days, and I was not sure I had the knowledge or the experience to put on trades based on politics. I also knew that I had got the market response to the election of Trump very wrong, so in a political world, I thought it was time to take a break. But after a few years on the side-lines, I think I know when I can see a pretty clear political opportunity in the markets.

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The key trade of GLD/TLT continues to trade well.

I originally posited that this trade would be due to a political reaction to excess of pro-capital policies, and politicians would be forced to adopt pro-labour policies. This would lead to higher wages, higher inflation, higher interest rates, and falling asset prices in real terms. Following this line of thinking, speculative assets would struggle. But with assets like crypto and listed private equity soaring to new all time highs, this analysis seems wrong.

One possibility is that only China has moved pro-labour, and this is enough to cause GLD/TLT to trade positively, but the rest of the world remains pro-capital. I did think that China moving pro-labour would force the rest of the world to follow, but this seems to be taking longer than expected.

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A few years ago, a friend of mine really got into the crypto area. I expressed my doubts, and he said I should listen to Michael Saylor. As advice to convince me of the merits of cryptocurrency, this was NOT good advice. As someone who made a career out of short selling, Michael Saylor videos were the ultimate red flags. The sail boat in the background, to the careful curation of “bitcoin resources” to be only on-message, with little talk of the potential downsides were classic red flags. Other red flags was a SEC investigation during the Dotcom boom for inaccurate financial reporting, that saw him settle. Typically when an executive has been caught out once, the disincentive to being caught out again is reduced. There is a famous Australia hedge fund manager who looks to short companies that employs people investigated by the SEC and other such financial organisations, who is doing quite well as far as I know. The website has a strong promotional vibe - another red flag.

I was not alone in questioning both Michael Saylor, bitcoin and his strategy. Microstrategy quickly became one of the most shorted companies in the US, with over 40% of its outstanding stock out on loan, with a borrow cost of up to 35%. This was no doubt driven by the leveraged nature of Microstrategy’s investment into bitcoin, and the knowledge that there was potential for a margin call at USD 25,000

However, Michael Saylor and Microstrategy survived the crypto bust of 2022, and have just announced additional purchases of bitcoin to take Microstrategy’s holding of Bitcoin to 1%. The idea of controlling supply to drive up the price of an asset has a long and in recent years almost singularly successful history (Hunt Brothers tried to corner the silver market in 1979, BHP trying to buy RIO in 2008 are examples of failed attempts). I have to admit he may well prove successful in his strategy.

Sam Bankman-Fried (SBF) and Michael Saylor both studied at MIT and are now both heavily associated with crypto. In contrast to Saylor, SBF and his FTX were seen as “the good guys” in crypto, with big name investors and supporters. This good guy image meant there were clearly many red flags that investors glossed over. At the heart of the bankruptcy of FTX, was the failure of the FTX cryptocurrency FTT. (Full disclosure - a relative worked at FTX)

My point here is that as SBF was trusted, he was able to use his own crypto currency as collateral, and get away with poor corporate governance structure. The markets belief in SBF meant that it created a structure that could fail. The market’s (and mine) lack of faith in Michael Saylor meant that he needs to have a very transparent and robust structure. As far as I know, there has been no push, and no demand for a Michael Saylor cryptocurrency (If such a thing actually came about, it would be a good sign that crypto area was getting frothy again). And here is the irony, the current success of Michael Saylor probably owes a lot to the markets lack of trust in Micheal Saylor. Or as an old fund manager once told me, dodgy assets are ok, as long as they are priced as dodgy assets. The problems happen when dodgy assets are priced as good assets. The GFC, Eurocrisis and now FTX are reminders of the financial paradox of dodginess - that dodginess is only really a problem when it is not priced in.

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I love patience, I hate stagnation. I have been talking about a pro-labour (anti-capital) move in politics and markets for some time. For nearly 18 months, I have been recommend long GLD, Short TLT. The short TLT part has been much better than expected, but GLD has held up much better than I would have expected given the level of monetary tightening, but that was the point of the GLD/TLT trade. The fund manager in me knows that when you have a winning the trade, the key is patience. The problem is publishing versions of the same idea on substack is a bit stagnant in my view.

The GLD/TLT trade has a long way to play out. Ultimately, I think this plays out in a 1970s style spike in yields, and rising commodity prices. We can proxy this using a US treasury return index and gold prices. As I have pointed out, TLT is a great product to short in rising rates environment, as it has no pull to par. The implication, is that we are still in the foothills of this trade. Soaring inflation, or potential default could get us to the end game here (or some combination of both).

Even though Long GLD/short TLT is a great trade, it is NOT the basis of a successful fund. If your basic fund structure is GLD/TLT, a semi-competent allocator will just go out and replicate it directly (and avoid paying fees to me). This is the brutal reality of the fund management industry - and cannot be avoided. So how do you take an idea of GLD/TLT and turn it into a marketable product? The first thing you need to do is put yourself in the shoes of the allocator. What do the ideas behind GLD/TLT mean for the allocator. Well as mentioned in my last post, AUM is still flowing to Private Equity. Blackstone has USD 1 trillion of assets, and total industry estimates of USD 12 trillion.

Private Equity offers many benefits. It uses debt to juice returns. It also uses internal valuations, so at least gives the appearance of stable returns, and as pointed out again in the last post, with long term bonds only yielding slightly more than inflation, the temptation to put money to work with private equity is strong.

The problem of course is that GLD/TLT in its extreme form implies that private equity is, to use a technical term, fucked. The extreme form of GLD/TLT implies not only rising interest rates, but rising taxes, and rising costs. More of the profit pie will go to labour, and costs should rise across the board. This is already affecting other industries that have been reliant on financing to grow, such as REITS.

Or even boring, easy to leverage businesses like utilities.

So suddenly, I can see an investment strategy that has an attractive business strategy. Building out short bias fund that makes money when private equity lose money. Why is this a good business strategy? And semi-competent allocator should be worried about their allocation to private equity. What if interest rates go to 10%? The problem is that private equity money is locked in, and difficult to exit. An allocation to a fund that makes money when private equity goes wrongs makes a lot of sense. All of this might sound theoretical, but I am speaking form experience. When I started out in fund management, I started in emerging markets in 2002, as I knew China was the next big thing. As it worked out, this was perfect timing, and I benefited from the huge bull market from 2002 to 2007. But by 2010, I knew China was, to use a technical term, fucked. So basically went out and shorted China related names, with a view that a China crisis and devaluation was inevitable.

I had a far better business being bearish on China from 2011 onwards, than ever had being bullish. Why? Because allocators had big positions in emerging markets and commodities that they could not easily sell. My view was that China would follow Japan and Korea and devalue it way out of credit problems. Instead China has chosen to close the capital account in 2016, and the short emerging market trade became extremely volatile.

After taking a few years off, to think about why China chose not to devalue and what that means, I have a new pro-labour/anti-capital model that I use (anti-capital politics chooses not to devalue as it reduces real wages), which means that currency devaluation is not the destructive force in markets anymore, but rising interests rates are. The continuing sell off in JGBs confirms this view to me.

So what next? Well I am now going to build an “anti-private equity” portfolio - just as I built an “anti-China” portfolio back in the day, which will combine the use of equities, bonds and (maybe) currencies. Once I have built that, I will provide a monthly newsletter talking about positions etc. This will only be for paying subscribers. And if I like the look of the portfolio, and there is a market appetite for it, then I may launch a fund. In simple terms, this substack is moving from theoretical to practical. Exciting times!

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The great thing about having a model to think about markets is that you can adjust it as data comes in, and then make new conclusions or adjust the model as you need. This year has seen the Nasdaq return 30% so far this year - recovering most of its losses from 2022. Rather than looking at the index we can look at individual stocks to get more detail. Apple is now a USD 3 trillion stock, is at all time highs, and is worth more than many counties entire stock markets. Apple alone is 12% of the Nasdaq 100, a level of market concentration we used to only see in emerging markets. Lets just look at Apple for the moment to try and understand markets. Earnings estimates for 2025 have not really changed much (this can be lagging at times), so what has driven the move in Apple?

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Ideas are easy, execution is hard. The idea of a shift pro-labour from pro-capital is actually very easy to understand. Pro-capital policies have become unpopular, and the road to electoral success is now paved with pro-labour policies. Looking at minimum wages to the S&P 500 or house price to income ratios, it is very easy to see either wages rising substantially. My view on how this happens, is that as wages rise, consumption surprises to the upside. Poor people, by definition, tend to spend rather than save so as you give them more money, the multiplier effect is much larger than the “wealth” effect. This creates inflation, and central banks raise rates, which puts pressure on asset prices. The simplest expression of this is long gold, short treasuries (GLD/TLT) which has continued to trade very well.

Running with this logic a bit further, the policy should be aiming to reduce income inequality, and favour small caps of large caps for example.

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“The Price Is The News” is a concept shameless ripped off from the macroman blog run by Cameron Crise, now of Bloomberg fame. Its a great concept, and in essence what it means is that when price moves in stocks are the news, it generally means that you should be very cautious. A good example is the recent news flow in regional banks in the US, where price is very much the news. I did not pick up the deposit outflow news in this sector, so I was surprised as most people when Silicon Valley Banks went under. And like everyone else, I went to look at what other banks could be under stress. I found 11 in a very quick analysis. Of the 11 banks I found that looked troubled, 9 have seen the share prices decline since the 15th March, despite a rising S&P 500, and 2 have had rising share prices. The biggest fall was 17% but one of the risers was up 73%, with a single day rise of 50%. That bank was First Citizens BancShares - and the reason was that it was acquiring parts of Silicon Valley Bank.

A short seller I heard speak once described such huge one day moves in short positions (often driven by M&A) as an axe to the forehead, as they are extremely painful, and come out of the blue. How can we avoid axes to the forehead? The above story shows you should be cautious shorting any area that is in the news. But understanding why regional banks are in trouble, should lead to some other short ideas quite naturally. So why are regional banks in trouble? For me the simple reason is that with Fed Fund Rate above the yield on lending to corporates, banks can’t operate profitably.

Here is where it gets interesting, as the market has basically assumed the next thing to happen is that the Federal Reserve will cut rates to protect the market, and we have seen huge flows into TLT US.

The irony of this is that this pushing down bond long dated bond yields everywhere, which is worsening the bank crisis. My view is that “political” changes means that inflation will not come down, and the Federal Reserve will likely not cut rates, and even if it does not by very much, before raising them again. So that view means that the liquidity crisis at banks will continues, and interest rates will keep rising. Where can we short, without breaching “the price is the news” rule, and avoiding axes to the forehead.

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Short selling is best avoided by every investor. One of the reasons I stopped managing money was not because I could not make short selling work, but I had one of my best short selling ideas come purely from politics - namely Chinese tech companies (rename Sino Stocks in the title as I feel like a bit of alliteration today). As I pointed out in my “Why I Stopped Short Selling” post of November 2022, my last great short selling trade was Chinese tech stocks. To quickly recap, I was reading Bloomberg, when an article flashed up that the Chinese regulator had asked domestic tech companies in for a meeting. This sounded bad to me, so after an hour search on the internet, I was able to find which companies had been called in - a screenshot is below.

For American investors, this was pretty much the entire make up of the KraneShares CSI China Internet Fund (KWEB US). As with any really good short - they halved from 90 to 46, and then promptly halved again. 82% peak to trough fall.

KWEB has been a fantastic short. In retrospect, what made it such a good short was that investors were buying the dip all the way down (falling down the slope of hope). For short sellers this should have been great, except that the rally in Chinese tech stocks over the last few months has meant that anyone who short sold KWEB in 2022 is now under water. If we look at fund flow into KWEB, we can see that as it first started to fall in 2021, investors aggressively bought the dip. And when the ETF started to fall again in 2022, short sellers added to positions. This makes KWEB one of those very special ETFs where neither short sellers or long buyers of the ETF have made any money.

Perhaps a better illustration of the how short selling sucks in the experience of short sellers in Alibaba. When it was first listed, it was common for the short and distort community of short sellers to claim that Alibaba was faking its numbers. Short interest in Alibaba remained elevated even as the stock even as more than doubled in 2017, inflicting significant losses. In 2019, for reasons that escape me short interest collapse, and remained at low levels until 2022, when short interest double just before the stock doubled again.

The problem with Alibaba for short sellers, and one I understood when I closed the position after it had fallen 50%, is how do I know that the Chinese government changes its mind, and decides that it actually needs Jack Ma? Alibaba has doubled from the lows, and is up 26% this year, and today we see news that Jack Ma has potentially come to a deal with the Chinese government. Maybe there are some short sellers out there who believe they have inside knowledge on the political machinations of the CCP, but I doubt it. I guess the point of this post is to show that successful short selling tends to work when you are all alone. Crowded and popular shorts is where short sellers goes to die - which is why I always endeavour to recommend shorts that are unusual and unshorted. Good luck out there.

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This material will be behind the paywall, as it is only useful to professional money managers and allocators. As the saying goes, “short selling is for show, long investing for dough”. What does this mean? Successful short selling can and will raise your profile massively, as it did for me, but the real money almost always comes from long investing. For professional investors who would like to add a net short fund to a portfolio of funds, pay up and read on.

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In the last update on short selling, I introduced the idea of supported and unsupported bull markets. One example I used was the experience of iron ore producers and Chinese steel makers, specifically Vale and Angang. The divergence between Vale and Angang in 2011 created an unsupported bull market - and signified that more research was needed.

When I took a closer look at the steel and iron ore industry one big difference stood out. The large Chinese steel makers where cutting capital expenditure (CAPEX) while the large miners were increasing CAPEX. That is the iron ore producers were gearing up to sell more iron ore, just at the Chinese producers were planning on selling less steel. One of these industries had to be wrong.

In this case, you could short iron ore miners with confidence. In the last note I highlighted another unsupported bull market, so I have been taking a closer look at that industry, to see if I can find a smoking gun like the chart above.

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I was having lunch with an old fund manager friend, and we were talking about my recent post - the three profit centres of short selling. I suddenly realised we were getting short interest ratio and borrow cost of a short mixed up. If veteran short sellers could get this concept confused, then anyone could. I thought I would do a quick presentation on the difference between the two and why it is important to distinguish between the two. In my view, borrow cost is a much better metric to look at, as it will be more likely to help you avoid career ending short squeezes.

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As mentioned in the three profit centres of short selling, consensus shorts have a nasty habit of rallying until all short interest has been destroyed. Recent examples include Tesla, Gamestop and AMC. This partly driven by the fact that a long owner who has lent the stock out short cannot physically sell the stock until it has been bought back by the short seller. Once I understood this concept, I make it a policy to avoid consensus shorts. But just because something is a consensus does it mean the market it wrong. So to try and make money from consensus shorts, I developed the idea of “unsupported bull markets”. The idea is pretty simple, so let me walk you through a few examples. The first one I found was between Chinese steel makers and iron ore producers. China is by far the world’s biggest steel maker and consumer of iron ore. In early 2011, the share price of Angang (a large Chinese steel maker) plunged on falling profitability, but Vale, a large iron ore producer continued to rise. I took this an opportunity to short Vale in 2011. If your largest customer is in trouble, you are also in trouble.

A few years later we saw a similar dynamic play out in the US. Chesapeake, a large US natural gas producer, had seen its share prices collapse in 2014 due to the glut of natural gas in the US. Despite this, Williams Brothers, a pipeline operator that relied on Chesapeake for 25% of its revenue continued to trade at all-time highs. Eventually the market worked out again, that if your largest customer is in trouble, you are also in trouble.

So where are the unsupported bull markets now?

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