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Legendary short seller warns the stock market is in ‘golden age of fraud’

Legendary short seller warns the stock market is in 'golden age of fraud'
Elmaz Sabovic

For years, the Federal Reserve’s (Feds) policy of maintaining lower interest rates has significantly fueled a bull market in stocks, and despite the Fed’s recent rate hike campaign to combat inflation, this bull market persists, raising critical questions about the future of short selling

Speaking on ‘Bloomberg The Close’ on June 12, legendary short seller and President and founder of Chanos & Company, Jim Chanos, shared his perspective on AI, meme, and solar stocks, highlighting the importance of short sellers in the current market.

“I call this the golden age of fraud. So there’s just so many companies, so many companies now that are playing games that are to try and take advantage of investors. So we need short sellers more than ever. But the government is cracking down on all of them,” Chanos said.

Decline in short-selling activity

As tracked by Hedge Fund Research (HFR), the number of hedge funds’ short buys has dramatically decreased, falling from over 50% in 2008 to just 14% in recent years. 

In particular, Chanos attributes this decline to the low-rate environment and the 15-year enduring bull market. He notes that a similar trend occurred in the late 1990s when the number of short-buyers dwindled just before the market experienced significant downturns from 1999 to 2009. 

The prolonged bullish trend, supported by Fed policies, has discouraged short selling, leading to fewer funds dedicated to this strategy.

Short-buys by hedge funds throughout the years. Source: HFR and Bloomberg
Short-buys by hedge funds throughout the years. Source: HFR and Bloomberg

For Chanos, 2021 is the most speculative market he has witnessed in his 45-year career, and he notes a resurgence in speculative behavior akin to that period. 

“It’s as attractive a time as it was in the first half of 2021, and I’ve said publicly that 2021 was the most speculative market I’ve ever seen in my 40 years of 45 years of investing. And we’re getting back to that,” Chanos concluded.

He points to the renewed interest in meme stocks such as GameStop (NYSE: GME)  and special purpose acquisition companies (SPACs) as indicators of this trend, emphasizing the importance of insurance in investment portfolios due to its current affordability.

The role of short sellers in the stock market

Chanos asserts that today’s market is more speculative, with increased retail participation driving significant option volumes and speculative trading. 

To navigate this environment, he advises adjusting risk parameters and the size of short bets as a risk-reducing strategy.

Ultimately, Legendary trader believes that short sellers are a crucial part of the stock market economy, as they highlight the discrepancies in stock price and fundamentals, thus warning the broader trading community about the potential dangers.

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