Short sellers can lead the way to true stock prices discovery – Business Daily

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Short sellers can lead the way to true stock prices discovery

A trader talks on the phone as he works on the floor of the New York Stock Exchange. PHOTO | REUTERS

May I have your attention, please? Will the real short sellers (traders who make money by borrowing stocks and selling them, with the hope of buying them back later at a lower price) please stand up?

I repeat, will the real short sellers please stand up? We’re going to need your help here. Some of the stocks need some real ‘’whooping’’. The perennial laggers.

The ones with heavy debt loads and low returns to equity. The ones with overrated and overpaid executives (yes, we know you) championing misguided strategies.

Unfortunately, it’s looking awfully peaceful out here in the markets. Where are the sceptics? Where are the short sellers to bet against this class of underperformers? Is it the fear of short squeezes – occurs when a heavily shorted stock starts to head higher and shorts rush to cover their positions due to fears that they’ll suffer unlimited losses if they don’t buy. Are the regulations too stiff to effect any short selling action? Or are investors just simply unaware?

Year to date, the economic environment has increasingly worsened – inflation is at a three year high (7.1 percent), Purchasing Managers Index has reversed down below 50 – a level signifying a drop in business confidence while the local unit has weakened.

Markets (read: the Nairobi Securities Exchange 20 Share) have dropped some 12.4 percent this year. Foreign investors have been net sellers – net selling over Sh40 billion worth of stock from 2020 to quarter one 2022.

With this background, I am baffled why some names are still trading at lofty price-to-earnings (P/E) ratios and book values.

I am even shocked why a great majority of the regulated persons (read pension funds, insurance companies, investment funds, exchange-traded funds and commercial banks) still choose to remain exclusively on the long side. Short sellers should be here to keep these markets honest.

The lack of ‘’shorting’’ action means the negatives of some of these publicly traded securities go unseen. It means there’s no one to counter the blind enthusiasm, ignorance and occasional fraud that otherwise may run unchecked.

This has an unintended consequence; the ‘’true price discovery’’ is limited. Only shorts have the motivation to look beyond the happy talk of company press releases and sell-side analyst reports.

The bottom-line is that it provides a hedging framework that works. For instance, mark-to-market losses at the fund level, if hedged properly, can more than compensate for portfolio losses owing to the increased value of hedges. Indeed, it is a healthy ‘’evil’’.

To extend this point further. Perhaps, it is time to broaden the class of shorts to also include unregulated persons (read: qualified retail investors). Since the market needs people on both sides to make a market, I believe this addition can add liquidity and much-needed confidence.

If retail investors are already shorting international equities (via Contracts For Differences), why not local equities? There’s a short seller in all of us. So, may the real short sellers please stand up.

The writer is managing director Canaan Capital

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