Tharp's Thoughts Weekly Newsletter (View On-Line)
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Shorting an Empire?
We could debate mightily about who has the toughest trading job on Wall Street but it would be tough to argue against short sale specialists having a spot near the top of that list.
Institutional short sellers are different from the other folks on the street who are picking names to buy. To understand just how tough it is to be a short seller in the money management world, I talked with a professional short seller.
After considering the challenges of institutional short selling, we’ll look at what one of the most famous short sellers of our era has to say about shorting opportunities related to China.
The Trials and Tribulations of Being a Short Seller
As a fascinating starting point, one might say that my partner, Christopher Castroviejo has short selling in his DNA. Christopher’s grandfather, Benjamin Smith, was the one of the largest short sellers (if not the largest) during the market crash that started in 1929. This earned him the nickname “Sell ‘Em” Ben Smith.
For seven years, Christopher ran “short only” money for some firms and high net worth individuals who are household names. He and his firm TC Management had some amazing short side scores including Clearly Canadian and Citibank.
I asked Christopher about the general differences between traders who short stocks for a living (like the hedge fund manager we’ll discuss below) and the much more common stock purchasing manager, Christopher had some interesting and useful insights.
- Fighting the market’s long-term bias. Almost everyone knows that the U.S. equities markets have been in a long-term uptrend. So putting together a portfolio of stocks that will head down takes more work and patience than finding ones that will move up along with the market. It’s kind of like a salmon swimming upstream.
- Short sellers are often in positions early and have to wait. Those on the short side (and their clients) often have to have seemingly infinite patience. No one at the company wants their stock price to go down, so the efforts to keep price up often delay the inevitable for many quarters or even years.
- Short selling is a mental stretch for clients. Most money management clients want smooth returns, and equity curves for short portfolios are usually anything but smooth! The waiting game I mentioned above can be tough for clients to endure.
- Good short trades get crowded. When ideas start to work, “me too” traders start to pile on. With lots of short interest in a stock, short squeezes can become painful. A short squeeze happens when price rises enough that those short the stock have to start liquidating all or part of their position. Since exiting a short trade means buying the stock, this extra buying adds fuel to the up move.
The bottom line is that successful short sellers have to do more “on the ground” research and dig deeper into a company’s information to find ideas than those who are buyers. Channel checks (how much product or service volume is really flowing) require even more due diligence. Accounting reviews move from routine to full-out forensic exercises. Because of the extra due diligence, short sellers with good, long-term track records are rightfully held in high esteem.
A Short Seller with a Record of Success
Jim Chanos, founder of Kynikos Associates, is widely recognized as one of the best short sellers in the business. He was famously involved in uncovering the problems at Enron and WorldCom (he was, of course, short their stocks) and has had admirable performance over a very long short-selling career.
His latest idea for a slide is the weakness he sees in China. His research into the problems with China have led him to be a very outspoken short seller of venerable Caterpillar. He says that this short was already his most profitable play for 2013.
Chanos has made several public presentations about the problems with China and backed his position with lots research and data. Chanos’ analysis is noteworthy for all serious traders and investors because China has become such an important player in many areas of the global economy that any contraction in the Middle Kingdom would have worldwide ramifications.
Yeah, We Get It — China Is Important
Few people need convincing that China is a pivotal player in the world economy but to drive the point home, here are some great charts by Australia’s Treasury Department in 2011.
It isn’t necessary to dig into the details because the point is clear: China is the world’s leading consumer of construction commodities by far. Thanks to its rapid urbanization and growth goals, it has become the primary consumer of base metals like steel, aluminum and copper. They are also the world’s top user (and producer) of coal. The list could go on and on — but we get the picture: China’s growth and consumption have been huge drivers for the global economy. If that growth sputters, reverberations will be felt just about everywhere.
Why Chanos Doesn’t Like China
When a smart guy with a track record like Chanos repeatedly sounds the alarm, on a lynchpin to global economic health, it’s at least worth a listen. To keep this piece from getting even longer, though, let’s look at some of the key concerns on China in bulleted fashion:
- China’s GDP numbers are suspect. This isn’t the first time you’ve heard this (gaps from regional numbers vs. national numbers, etc.), but even with number fudging, the slide in GDP persists:
- China continues its overinvestment. Chanos lists some numbers like 12% too much cement capacity, 10% on steel and 18% on autos — and these are compounded annual growth rates for the past 5 years! This bleeds over into a fixed asset investment boom that’s hard to fathom… The chart below shows Fixed Capital Formation as a Percent of Gross Domestic Product.
- Compare’s China’s fixed asset investment rate of 45% to the U.S. at 15%, Japan at 21%, and even high growth Brazil which is only at 21%. We’ve all heard of empty cities and huge shopping malls in China with less than 10% occupancy. And the economic accounting for the drag these projects put on the economy? About as reliable as their GDP numbers.
- All this tastily funded by a credit boom. When China tried to start some banking reforms recently, the stories of undercapitalized banks made front and center headlines which precipitated a 10% stock market plunge in two days.
- China’s real estate bubble is in full swing. The affordability index for big city housing is off the charts! Check out this living expense comparison for several Chinese cities and notoriously pricey London and NYC:
- Wages are rising, putting stress on margins and manufacturing costs. This trend is pushing some manufactures to “offshore” work from China to cheaper labor markets. According to the official People’s Republic of China government website (gov.cn), private sector manufacturing pay rose 16% in 2010 and 11% in 2011. Minimum wages are also scheduled to rise 13% through 2015.
To be honest, this is only the tip of the iceberg of Chanos’ China thesis. The Chinese peoples’ lack of faith in government to control graft and wealth hoarding signal additional warnings.
Cut to The Chase - What Investors and Traders Should Do
You may not have the deep pockets and infinite patience of Jim Chanos to be able to short China-dependent stocks, but you can use China as one of your early warning “canaries in the coal mine”.
Every investor and trader should add the announcement of China’s GDP numbers to their “data to watch” list. The next one will be in mid-October. In addition, realize that China related stocks, like base metal miners and most commodity related plays, should be kept on a short leash.
Because China is a command economy, the central government has many levers that it can still pull to delay a slowdown (and to adjust the numbers so that the slowdown looks less apparent). But a lot of smart money is betting on just such a slowdown. As individuals, we’d do well to err on the side of caution as well.
If you’ve found this article useful or thought provoking (or both), I’d love to hear your thoughts and feedback — just send an email to drbarton “at” vantharp.com.
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News from VTI
Changes to the Super Trader Program
In January 2012, we made a number of improvements to the Super Trader program and in the process, we tried to anticipate what could go wrong. While we looked at various contingencies, we tended to focus on the negative side, rather than the positive side. As a result we did not anticipate one very positive problem — that the program would fill up. Yes, that's right, the program is full for the remainder of 2013. Actually, I can handle coaching more people, but our workshop facility barely has enough space to hold our Super Trader Summit this year. Our workshop room will hold 50 people (without tables) and we will probably have that many at our annual summit this year.
Because the program is full, we will wait to accept new entrants until some of the current Super Traders finish in 2014. Until now, I have been accepting two entrants per month. However, when we reopen the program in 2014, we can only accept one new person per month until we solve our space problem.
In addition to the number of entrants we will be able to accept per month, we will also make three other changes:
First, I need to modify one part of the application process. One of the screening criteria for acceptance into the program is attendance to either the Peak Performance 101 Workshop or the Oneness Awakening Weekend. Because these two workshops require participants to engage in transformational processes, I am able to observe whether someone is ready for the more intense work required in the Super Trader 1 phase.
Occasionally, someone interested in applying to the Super Trader program has attended one of the workshops—but more than a year back. We have three to four Peak 101 Workshops and four to six Oneness Awakening Weekends each year and I see between fifteen and forty people at each one of those events. That’s a lot of people and after a year or so, I don’t effectively remember the kinds of details I need to know about someone applying to the Super Trader program.
Change 1 — As a result, if it has been more than one year since you attended a Peak 101 or Oneness Weekend, we now ask that you attend one of these workshops again. The price of repeating the workshop will be half-price and, if you are accepted into the program, this repeat workshop fee will be credited 100% toward your Super Trader fee. Also, if you attended Peak 101 in the past and want to attend Oneness instead, that would count and vice versa.
My next change regards the entry process. My top priority for every person interested in the Super Trader program has been and continues to be that program is right for you. The realization that someone is not a good fit for the Super Trader program has generally showed up very early in their enrollment. Rather than having someone make a large, non-refundable payment only to find out the program is not a good fit for them, I am adding one qualification step for full entry in the program. This change will help every incoming Super Trader understand very quickly whether or not the program fits them.
Change 2 — From today forward, applicants who meet the screening requirements (see below), will pay a non-refundable $7,500 deposit and will receive the first Super Trader lesson immediately. You will be expected to send me weekly reports as you work on this lesson. Once you have proven that you will stay in regular communication with me and you have completed the lesson to my satisfaction, you will be fully accepted into the program. You can then start lesson 2 and continue the rest of the program- either right away or when a spot becomes available (if the program is full at that time).
Since the program is now full, this change applies to any new applicant. Right now, no one has made a deposit for 2014, so the first applicants to finish lesson 1 will be admitted in early 2014 (probably February or March). Once we have solved our space problem, we will also resume accepting two new entrants per month.
This new step in the process does not add any time for your entry into the program because every ST has to complete lesson one anyway. Hopefully, this new step will help you determine if you want to continue with the program before you have to make your first large payment. However, you will not be able to attend workshops (at no charge) or the Super Trader Summit until you have been fully accepted into the program.
The cost of the program is the third change. Our original program (before January, 2012) cost $50,000 for two years, or $25,000 per year.
In 2012, we implemented a longer, two-phase structure to the Super Trader program which put the cost for the whole program in a price range from $45,000 for four years to $65,000 for six years. In other words, the cost of the program went from $25,000 per year to just over $10,000 per year. No wonder the program has filled up so quickly since then! As a result, our workshops have been selling out, largely because we have so many Super Traders attending. I am happy about this because Super Traders make outstanding workshop participants.
However, we need to raise the price for the program closer to its true value, although it will still cost less per year than the original program.
Change 3 — The new price will average about $15,000 per year. Thus, the price for Super Trader 1 (ST1) and Super Trader 2 (ST2) will be $45,000 each. However, you can significantly reduce the cost of the program by finishing faster. Since I believe that the best way to complete the program is by going through the lessons for ST1 in a steady manner, I reward Super Traders who finish ST1 (to my satisfaction) with lucrative incentives —
- If you finish ST1 in a year, you get a $30,000 credit for ST2.
- If you finish ST1 in 18 months, you get a $22,500 credit for ST2.
- If you finish ST1 in two years, you get a $15,000 credit for ST2.
Criteria for Full Admittance to the Super Trader Program as of July, 2013
- Attendance at Peak 101 and/or the Oneness Awakening Course (within the past 12 months) during which Dr. Tharp can gain a sense of your personal responsibility, your awareness and your desire to work on the most important factor in your trading—you.
- Submission of an application and a personal statement of commitment.
- Have read Trading Beyond the Matrix: The Red Pill for Traders and Investors.
- Proof that the program makes financial sense for you. Paying for the program should leave you secure about your finances.
- The Van Tharp Institute’s approval.
- Receipt of down payment.
- Weekly communication with Van until Super Trader Lesson 1 is complete to his satisfaction.
For more information on the Super Trader Program, click here.
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