8/12/2019 Chanos 2010

1/15

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

8/12/2019 Chanos 2010

2/15

2Hosted by CFA Institute (www.cfainstitute.org)

Short Selling Is:

Essential Not the opposite of going long

A large alpha-creating strategy Important to theoretical finance Non- regulatory watchdog functions

8/12/2019 Chanos 2010

3/15

3Hosted by CFA Institute (www.cfainstitute.org)

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.)

8/12/2019 Chanos 2010

4/15

4Hosted by CFA Institute (www.cfainstitute.org)

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

8/12/2019 Chanos 2010

5/15

5Hosted by CFA Institute (www.cfainstitute.org)

The Constraints

Must borrow shares; possibly pay rebate Regulatory rules

Concept of negative reinforcement Outright bans temporary or otherwise

8/12/2019 Chanos 2010

6/15

6Hosted by CFA Institute (www.cfainstitute.org)

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

8/12/2019 Chanos 2010

7/157Hosted by CFA Institute (www.cfainstitute.org)

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"

8/12/2019 Chanos 2010

8/158Hosted by CFA Institute (www.cfainstitute.org)

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

8/12/2019 Chanos 2010

9/15

8/12/2019 Chanos 2010

10/1510Hosted by CFA Institute (www.cfainstitute.org)

The Theory

Essential to CAPM William Sharpe s 1990 Nobel Prize acceptance

speech The 3Com/Palm episode

8/12/2019 Chanos 2010

11/1511Hosted by CFA Institute (www.cfainstitute.org)

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

8/12/2019 Chanos 2010

12/1512Hosted by CFA Institute (www.cfainstitute.org)

Short Selling: Sources of Ideas

Experience Third-party research Screens, etc. Other money managers (not necessarily other

short-sellers) Our partners/investors Experience

8/12/2019 Chanos 2010

13/1513Hosted by CFA Institute (www.cfainstitute.org)

Short Selling: Some Recurring Themes

Booms that go bust Consumer fads

Technological obsolescence Structurally flawed accounting Selling $1.00 for $2.00

8/12/2019 Chanos 2010

14/1514Hosted by CFA Institute (www.cfainstitute.org)

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

8/12/2019 Chanos 2010

15/1515Hosted by CFA Institute (www cfainstitute org)

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