RPT-BREAKINGVIEWS-Endangering bears lets AI animal spirits run wild

By Jeffrey Goldfarb

NEW YORK, Dec 3 (Reuters Breakingviews) - As the Alpine bear population neared extinction last century, Italy's red deer were freer to eat the mountainside vegetation, steadily throwing off the habitat’s fragile equilibrium. A similar ursine imbalance threatens markets today, as short sellers become an increasingly endangered species. With artificial intelligence feeding animal spirits, a lack of predators will extend the lifespans of financial weasels and hyenas.

Knives are out again for financial skeptics. Palantir Technologies PLTR.O CEO Alex Karp in early November took aim at Michael Burry of “Big Short” fame and Andrew Left of Citron Research, both of whom targeted the software company and its valuation of more than 200 times earnings. Karp accused such investors of “market manipulation.” A couple weeks later, Opendoor Technologies OPEN.O boss Kaz Nejatian gleefully unveiled a special distribution of warrants to shareholders, saying it would “ruin the night” for those betting against the $7 billion home flipper he runs, whose stock price has jumped 400% this year.

These are well-trod hunting grounds. Lehman Brothers CEO Dick Fuld blamed naked shorts, or those who sell shares before borrowing them first, and “rumor mongers” for the collapse of rival Bear Stearns and contributing to the 2008 bankruptcy of his investment bank. Elon Musk, Tesla’s TSLA.O billionaire boss and self-proclaimed free-speech absolutist, routinely rails against what he calls “value destroyers,” amplifying opprobrium that stretches back at least four centuries to the Dutch East India Company. Nowadays, hordes of meme-stock buyers, higher borrowing costs and stricter rules are also increasingly squeezing the doubters.

The numbers suggest bearish investors are roaming freely. Cumulative short interest in companies tracked by the Russell 3000 Index .RUA grew to $1.4 trillion in mid-November, roughly 20% higher than a year earlier, according to data cruncher S3 Partners. The volume also represents about 3.8% of total market capitalization, double the nadir from early 2023, but below the nearly 5% peak reached in 2021, using LSEG sums.

Those figures, however, in large part reflect a rise in so-called market-neutral strategies, where hedge funds try to balance long and short positions. In other words, the bearish bets are mostly penned in for trades used to offset bullish ones.

Genuine negative nellies who ferret out everything from bloated valuations to fraud are indeed dwindling. The number of hedge funds with a short bias has dropped from more than 50 in 2008 to just 10, while their assets under management roughly halved to less than $4 billion, industry tracker HFR reports. Activist short campaigns, like the one being waged by Daniel Yu of Gotham City Research against $25 billion document and data manager Iron Mountain IRM.N, also tumbled 40% from 2019 to about 100 last year, as tallied by governance and compliance software vendor Diligent.

One recently closed shop is Hindenburg Research. Founder Nate Anderson disbanded his small team in January, saying in a farewell letter that regulators had charged nearly 100 people based at least partly on the firm’s work. Trevor Milton, who started electric truck-maker Nikola, was among them.

Jim Chanos endured significant losses before deciding in 2023 to return capital to investors after a long run that featured shorting Enron before the energy company collapsed under an accounting scandal. He now teaches about the history of financial misdeeds at Yale and shares opinions with 56,000 followers on X. Burry, who had misgivings about subprime mortgage securities ahead of the 2008 housing crisis, shut down his Scion Asset Management last month. Days later, he unveiled “Cassandra Unchained,” a Substack that has already attracted more than 120,000 subscribers.

It is probably harder than ever to bet against stock prices. The S&P 500 Index .SPX has soared almost 90% over the past five years, powered by pandemic-related fiscal stimulus followed by the artificial intelligence boom. The advent of meme stocks also presents fresh challenges, as swarms of retail investors unite around struggling companies such as retailer Bed Bath & Beyond BBBY.N, propping up the price and forcing short sellers to cover their positions. The cost of borrowing shares to make the trades has also reached “the highest in U.S. recorded history,” at an annualized cost of more than 100% for hundreds of individual equities, Acadian Asset Management wrote last year.

Ever since the Dutch outlawed short selling in 1610, professional gloomsters have been routinely targeted by regulators. New rules keep coming despite at least some evidence that the practice does not exacerbate market-wide declines, as critics often claim. Starting in 2026, U.S. fund managers are due to report monthly to the Securities and Exchange Commission any short position bigger than $10 million or 2.5% of the issuer’s outstanding shares, which threatens to restrict shorting activity by discouraging investors from crossing the disclosure threshold. A modification or rewrite may be coming under newish SEC Chairman Paul Atkins, however, after an appeals court recently ordered the agency to assess the economic impact.

Scaring off bears will do more harm than good, especially at a time when the White House is turning a blind eye to white-collar crime and pardoning those, like Milton from Nikola, convicted for it. Feverish AI dreams are elevating stock valuations and exuberant investors have a history of gullibility. With fewer sharp-clawed beasts prowling the markets, the inventory of financial deception is bound to pile up and fester unnoticed for longer than usual.

There is also no shortage of research indicating that short selling has vastly positive effects on capital markets. One 2024 academic paper, for example, studied Chinese stocks from 2009 to 2020 and found that an increase in bearish bets could correct mispricing and mitigate market "irrationality." Full-time cynics help keep tabs on corporate governance deficiencies and improve price discovery by ensuring that questionable practices get as much attention as the chirpy spin from boardrooms. As another study put it: "Stocks with higher abnormal shorting are priced more efficiently as observed by smaller pricing errors." In other words, bears serve a purpose.

The European Union realized as much, too, and eventually helped reintroduce the predators back into the Italian Alps. Thus followed a string of attacks on livestock and humans, spawning the label “orsi problematici.” A small number of analogous problem bears exist in investing circles, too, and deserve to be removed from the environment. Broadly speaking, however, it would be better to find a way to live in harmony with these creatures to keep nature in balance.

Follow Jeffrey Goldfarb on X and Linkedin.

CONTEXT NEWS

Michael Burry, whose bets against the U.S. housing market in 2008 were made famous by the book and movie "The Big Short," is closing his hedge fund operator, Scion Asset Management, Reuters reported on November 13, citing an October 27 letter to investors in which he said he would liquidate the funds and return capital.

"Cassandra Unchained," a Substack newsletter, "is now Dr. Michael Burry's sole focus," he posted on November 24. It costs $379 a year to subscribe.