Short sellers have been getting pretty bad press lately. The most recent involves politicians in Europe trying to blame them for many of the problems affecting debt markets as the contagion of worry about whether Greece can afford to pay its bills (it probably can’t) spreads to other countries such as Spain (which should be able to) and Portugal (which almost certainly will run into troubled in a prolonged slowdown too). There is sometimes something to be said for the argument that short seller lead to increased market volatility rather than just better liquidity but in general shorts are just the messengers delivering bad news. They do not create it.
And lost in the politics of how terrible they all are is the fact that they often help serve other investors well by helping prevent bubbles. If more people had the opportunity to bet easily against house prices (not just the structured credits that financed them) then there may have been less severe housing bubbles and busts in many developed economies over the past decade. And I have just one example right now of a short seller who is doing me a great service. Not only that, but he is unusually open and transparent on his thinking about why he is selling a stock short. As such his posts make excellent reading and are a great lesson in investing for short sellers and long-only investors alike.
The posts all explain in great detail why Bronte Capital is shorting First Solar.
In a very small nutshell of a nuanced argument (so forgive me if I simply too much) John Hempton lays out why he thinks that First Solar, which is currently the darling of the renewable solar industry, is toast. First Solar has an innovative and low cost method of producing thin film solar modules. These are less efficient than the more conventional silicone ones, but are also much cheaper as they are mostly made of glass. In a long and well reasoned argument, John explains why he thinks that despite their great technology and innovative product, they will still in time be done in by cheap Chinese production of the older sorts of PV modules No matter how great the First Solar product, over time it just won’t be able to compete with cheap Chinese production.
Now the company itself and many analysts argue that First Solar will keep improving and will stay ahead by becoming cheaper itself as well as by making its modules better (more efficient).
Now disagreement is great. There is no right answer here because the future is inherently uncertain so different views of it can coexist. The idea of a market is to set a price on the stock by taking all of those different opinions. Now if John were not allowed to short sell, the most he could do is sell his holding if he had one, or just not buy if he didn’t. In essence you would then have a self-selecting group of optimists setting the price. That might not matter, you could say, since if they are wrong they are the only ones hurt. But in fact First Solar makes up a part of an index that I have bought (the iShares S&P Global Clean Energy index fund) in which First Solar is the biggest holding (5.7%). Now many people, myself included, might own the index because we want a hedge against oil and believe there is something to the longer-term growth story for renewable energy. So it is important for us that the index is priced correctly lest we become innocent victims of other people’s exuberant optimism for the stock. As it happens I agree with John and think that First Solar is pricing in too much growth and optimism, though am not in a position to short the stock Thanks to him my tiny passive stake in the company was bought for just a little less than it might have been without smart and brave people like him who are willing to bet against the crowd.