Carson Block on Short Selling in the Time of Coronavirus
Short seller Carson Block catapulted to fame almost a decade ago for exposing alleged frauds in publicly traded Chinese companies, like the well-known case of Sino-Forest Corp.
Block’s route to short selling was a circuitous one. He was born in New York City, grew up in New Jersey, got a law degree in Chicago then moved to China, where he worked as a lawyer before starting the country’s first self-storage company until real estate prices took off, making the venture uneconomical. That endeavor also gave him insight into the Chinese economy, eventually leading him to launch his short-oriented research firm, Muddy Waters, in 2010. The name comes from an old Chinese proverb that roughly translated says, “muddy waters make it easy to catch fish.”
While Block started out investigating alleged fraud in China, he has branched out to Europe, Canada and the U.S. in recent years. In 2015, he launched his first hedge fund, followed by another one in 2016. He had been planning to move his company from the San Francisco Bay area to New York City over this coming summer—but now is not sure.
The coronavirus crisis has made him wonder whether cities will be as popular places to live as they have been in recent years, or whether people will want to take mass transit again. (He’s looking to talk to an expert on the Spanish flu of 1918 for insights on that.)
Block is also wondering whether anything will change, particularly in China, which gave birth to the new scourge. A skeptic, he’s somewhat doubtful.
Worth recently caught up with Block, who is working from his Sonoma County home, to talk about China’s role in the coronavirus pandemic, short selling in times of market crisis—and human nature.
Q: You became known for short selling research in 2010, when you were uncovering fraud from Chinese companies like Sino-Forest. I’m curious what you thought when you first heard about the coronavirus in China?
A: I have been saying [for] many years, semi-facetiously, that if there’s ever a plague that wipes out much of humanity, it will have originated in China. And I was thinking squarely about wildlife markets. It’s this unhealthy, literally and figuratively, obsession the Chinese have for eating these exotic foods. And it’s obvious from when SARS started in 2002 that nothing changed.
The SARS virus also started in these wildlife markets. Why hasn’t the Chinese government taken action to shut them down or better regulate them?
I think the Chinese government is happy to placate. The reason why the government looks the other way on these wildlife markets is this is how a not insignificant number of people in China earn their scratch, particularly when you go on a province by province level. They did not have the political will coming out of SARS to make any changes to really crack down on wildlife markets.
Is this a common attitude from the government?
It’s the same thing with counterfeiting. They understand that the counterfeiting industry causes problems internationally. But that’s a way of making a living for a lot of people. It just happens again and again and again, just like you have people in China who think it’s acceptable and a good idea to cut infant formula with melamine so that they can make a little bit more money.
How do you think this changes our view of China going forward?
This gets into questions about where logic meets human capacity for wiping our memories clean of uncomfortable facts. Let’s talk about the first wave of outing these Chinese frauds. After those were exposed, by 2012, a lot of investors felt China was uninvestable. But by 2014, Alibaba was ready to IPO, and everybody lined up around the block to get their allocation in the IPO. And nobody wanted to remember or care about the problems with these China listings.
What are the problems?
The companies are substantially committing fraud; there’s absolutely no way to hold the people behind them accountable.
Let’s talk about short selling in the time of the coronavirus. I know we’ve seen some short selling bans in Europe. And in ’08 there was a huge cry against short selling in the U.S. Do you think something similar will happen this time around?
In ’08, it was the financial system dragging down the real economy. The short selling bans were put into place essentially to protect banks. At this point, it doesn’t seem like we need to protect banks. Also, the research shows that the short selling bans in ’08 actually exacerbated the declines in the stocks.
How are short sellers doing these days?
In terms of short selling as an investment strategy, especially now compared to going into ’08, there are so few assets dedicated globally to short-biased strategies. The managers who ran those strategies started getting carried out in ’13. So, the amount of selling in the marketplace today is long sellers, not short sellers. A short selling ban, on the face of it, is a solution in search of a problem, number one. But, the reason why it creates more problems than it causes is, when you get to an environment like this, all of these long-oriented investors suddenly look for hedges.
Can you explain?
If you take away my ability to hedge, then I really have to think about my position, because I’m tired of taking losses. If you’re taking that away from me, you know what? I’m going to trim or dump my position. So, boom, there’s more selling that comes into the marketplace.
Have you changed your strategy at all? In terms of what you’re shorting now? Are you taking doomsday type of hedges, as people call them, as opposed to the type of shorting called “activist,” where you publicly out the problems facing a company?
We’re largely in cash, maybe 60 percent cash right now, but we’ve also put on a number of positions. For years, we’ve looked at companies that globally are problematic companies, and they just didn’t quite make the cut for short activism, especially as we’ve gone deeper into the bull market, where complacency just really built up. So, we’ve had a collection of companies like these that we know are problematic. And so, we’ve put some shorts on, small shorts on some of those companies and that’s been doing well for us. We’ve been shorting some credit of companies like that as well. Credit’s been funky.
Is this going to be a good year for shorts?
It’s kind of funny because when we had those hiccups in ’16 and then in ’18, all of a sudden people remembered stuff doesn’t always go up, maybe I want to invest in a short seller. And so coming out of this though, might a more traditional, non-activist short selling or short bias product be more attractive? Maybe. I don’t know. The landscape will definitely be different.
How do you think it will change?
For years, I’ve been talking about this concept of people are anesthetized to risks. I feel like there’s a lot that we do to anesthetize ourselves, but I think monetary policy is a big part of it. I think that also pervades the real world where people don’t want to have these uncomfortable conversations.
So, having been in markets as a short seller, especially, I lamented for the better part of the past decade how short people’s memories are collectively, how easily they tell themselves that they don’t have to worry about risk. I think that’s a human trait, and maybe it’s a blessing. It wouldn’t surprise me if two years after this ends, people are like, “oh yeah, remember that one time we took a staycation home for a while?”
But maybe not. There’s a guy I know named Dylan Grice [the cofounder of Calderwood Capital Research]. He wrote a piece a few years ago in which he talks about research that had been done into this concept of cooperation versus competition in societies. The conclusion of the research, as Dylan explained it, is that societies throughout history swing back and forth between being dominated by cooperation or competition. The reason for that is, if you take humanity at day zero, a bunch of individuals who are trying to survive end up realizing eventually that they’re all going to do better if they work together, and one plus one equals three, so everybody cooperates.
But then, as society expands, you get some people who fall outside of the mold, and they say, “Hmm, I’m not with the program here. I’m going to do my own thing, and I want more.” Pretty soon, they start doing better than everybody else. The cooperators tend to live in a tight-knit, relatively tight band, in terms of quality of living and quality of life. Then, these competitors are people who are saying, “Hey man, I’m out there to compete.” They’re killing it, so more and more people start thinking like, “Hmm, you know what? I want to be in this for me, too. Screw your cooperation, I’m going to do my own thing.”
How does that work out?
Society starts getting filled with competitors. The problem is: things break down for everybody because you need a level of cooperation to make everything work. So then, the pendulum starts to switch back to propagation of cooperation.
Do you think that’s where we’re headed?
If we want to be optimistic about it, maybe. There are no atheists in foxholes.