• Short sellers look back on a good 2022
• Numerous factors have helped short sellers
• 2023 is likely to be more challenging
After years of a bull market, short sellers could finally rejoice in 2022. The Ukraine war, the energy crisis, the end of cheap central bank money and falling stock markets – they all benefited. Against this background, according to the “Financial Times”, short sellers have recently set up several new hedge funds.
Good times for short sellers
An ultra loose one monetary policy had made investors very willing to take risks in recent years. Among other things, they rushed into shares of high-growth but loss-making technology companies. But with the turnaround in interest rates, such shares in particular came under pressure. Because, on the one hand, these companies are usually more heavily leveraged and now have to deal with rising borrowing costs, and on the other hand, the current discounted present value of the future cash inflows expected for them decreases with higher interest rates. “There was so much imagination involved, but now that imagination has subsided,” said Renaud Saleur, who runs hedge fund Anaconda Invest, according to the Financial Times.
This was a good development for short sellers, as they profit from falling prices by short selling securities. This means that securities are sold that are not actually owned by the seller at the time – they are only borrowed for a fee and must also be returned to the lender at a certain later date. The seller (short seller) must therefore stock up on the share again by this date at the latest in order to be able to return it to the lender. If the share price falls in the meantime, the short seller can buy the shares at a lower price than he sold them beforehand. The difference between the selling price and the lower buying price is his profit.
Rising interest rates are also helping short sellers in other ways. Because they usually hold high cash reserves until they close their trades, which ideally means buying the shares at a cheaper price. Thanks to rising interest rates, they are now earning higher returns on these cash funds. In some cases, this interest income is even higher than the fees for borrowing the shorted shares.
Another positive effect from the perspective of the short sellers is the fact that the current weakness on the stock market is discouraging private small investors – especially those who jump into so-called meme stocks. The hype surrounding GameStop stock, for example, was a fiasco for short sellers, and some of them stopped betting against individual stocks as a result. But according to information from the “Financial Times”, the short sellers are now becoming bolder again, since in the current market environment it is less likely that they will be targeted by meme investors.
It’s getting harder for short sellers
But after the exceptionally good year 2022, it shouldn’t be any easier for short sellers in 2023. For one thing, it is essential for short sellers to pick the weakest stocks in the market, and this will become more difficult in the new year after the recent collapse of high-priced speculative stocks.
Furthermore, bear market rallies, such as those seen on the NASDAQ from mid-June to mid-August or early November, pose a risk for short sellers. In such cases, short sellers often stock up on shares to limit their losses. “You have to keep your nerve,” explained Renaud Saleur.
Alongside this, 2022 saw a significantly increasing correlation between the S&P 500 index and its constituent stocks. This makes it more difficult for funds that use pairs trading, a market-neutral strategy that involves betting that a particular stock will rise while at the same time making a bet that another stock in the same sector will fall. However, when markets move in only one direction broadly, this is not helpful for this strategy.
The year 2023 should therefore also be a challenge for short sellers, although numerous forecasts assume a lackluster development on the stock markets. But they could well become one of the few winners in 2023.
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