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Stepan Lavrouk
Stepan Lavrouk
Articles (634) 

Jim Chanos Believes Markets Have Gotten Too Speculative

The guru says we are living in the golden age of fraud

December 07, 2020 | About:

As someone who has made a name by exposing overvalued and fraudulent companies, it should come as no surprise that Jim Chanos (Trades, Portfolio) is naturally skeptical when markets are ebullient. Chanos made money in the early 2000s by being one of the first to call out Enron.

More recently, he has been right about fraudulent businesses like Wirecard (XTER:WDI) and Luckin Coffee (LKNCY), and has a highly publicized short against Elon Musk's Tesla (NASDAQ:TSLA). In a recent interview with Bloomberg, Chanos discussed the current market environment.

When things are too good to be true

Chanos's basic philosophy on bull markets is that the longer they go on, the less willing people become to critically think about prices and values. Things that are too good to be true become more and more attractive when you see other people around you making money by throwing caution to the wind:

"There's all kinds of companies that are just sort of mind-numbingly expensive, whilst having quite large problems. The market, for the most part, simply just doesn't care."

Chanos believes the Federal Reserve's bold monetary policy decisions have made it even harder for short sellers to make money. In a zero interest rate environment, companies can borrow at incredibly cheap rates - even if they are ultimately not great businesses - which means it takes much longer for them to start suffering the consequences of bad management. However, it's not just about debt - it's about psychology, as Chanos explained:

"We're back to the environment where investors feel they have very little or no downside, because they feel like they have a 'Fed Put.' And that's a dangerous, dangerous environment. We've seen that in both the 2007 and 2000 market tops - both were marked by a belief in the Greenspan and Bernanke Puts, and now it's a Powell Put."

If investors don't believe there is no way that central banks will let them lose money, that creates an attitude toward risk-taking. The belief that the government will always step in to protect retail investors and traders may be fuelling the unprecedented explosion in speculative activity in the equity options market.

What about institutional investors? One would think that sophisticated capital allocators would be on the lookout for a way to hedge themselves against a potential market downturn while valuations are at historical highs, but Chanos believes that even though institutional investors understand the logical reasoning behind his shorts, they ultimately don't care because they also seem to share the belief that fiscal and monetary policy makers will be the ultimate backstop.

One of Chanos' main services is the provision of a hedging portfolio for his clients. How does he explain to them the need for such a hedge in such a risk taking appetite? He points out that since the "Powell Put" is fully priced into the market (everyone knows that everyone knows the central bank will protect markets), any change in that viewpoint will lead to a rapid repricing of the market. In other words, it may take a long time for Chanos to be proven right, but when he is, the effect will be significant. When everyone else is throwing caution to the wind, it pays to be the person who is risk averse.

Disclosure: The author owns no stocks mentioned.

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About the author:

Stepan Lavrouk
Stepan Lavrouk is a financial writer with a background in equity research and macro trading. Specific investing interests include energy, fundamental geoeconomic analysis and biotechnology. He holds a bachelor of science degree from Trinity College Dublin.

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