Bear Raid? Let me tell you about bear raids. . .

Yeah, Baruch was grinning as he read a writeup of an academic study on bear raids (the full article costs money, sadly, and Baruch is mean. The writeup was found by our friends at Abnormal Returns), which like 90% of academic studies about stocks has as its conclusion something that anyone with half a brain and a couple of years of decent investing experience could tell you about in a shorter and more easily understandable way, with fewer equations. In this case, the study concluded that under certain circumstances concerted selling (ie a bear raid) can hurt a company’s fundamentals as well as its stock price and make the stock fall further. Makes sense to me.

However, to get to this otherwise reasonable conclusion, the authors construct a very strange scenario: the selling of ignorant but nasty bears convinces a company management not to undertake an otherwise profitable project. Looking at its tanking stock price, management understand the market to be non-supportive, and its judgement conclusive. They terminate the money-making project and forgo a great opportunity. Look: a bear raid hurt a company’s fundamental value, there you go, bob’s your uncle. Here is the full abstract of the article, by one Itay Goldstein (Wharton), and Alexander Guembel (Oxon):

It is commonly believed that prices in secondary financial markets play an important allocational role because they contain information that facilitates the efficient allocation of resources. This paper identifies a limitation inherent in this role of prices. It shows that the presence of a feedback effect from the financial market to the real value of a firm creates an incentive for an uninformed trader to sell the firms stock. When this happens the informativeness of the stock price decreases, and the beneficial allocational role of the financial market weakens. The trader profits from this trading strategy, partly because his trading distorts the firms investment.

Up until this point, Goldstein and Guembel sound sane, if a bit dull. Then they go off the deep end:

We therefore refer to this strategy as manipulation. We show that trading without information is profitable only with sell orders, driving a wedge between the allocational implications of buyer and seller initiated speculation, and providing justification for restrictions on short sales.


It’s all bollocks of course, and proof, if we needed any, that Oxford shouldn’t have a business school. It’s not that bear raids don’t suck, they do. And such a scenario could certainly happen, and I am sure it sometimes does. But in my experience the majority of company managements view the buy side as a bunch of ignorant 30-something hedge fund twits with the attention spans of crack-addicted carp, who couldn’t construct a balance sheet if Messrs Graham and Dodd were there to hold their hands. They know this to be true (and it really IS true as it describes me perfectly) because they meet them all the time and answer their inane questions.

The quite barmy conceit of the authors of the article, that the grizzled (ha ha, geddit? like bears?) management teams you find running public companies noawadays are going to pay attention to the short term shenanigans of this addled basket of dysfunctional ignoramuses, simply doesn’t convince me. For one thing the managers start with a huge information advantage over the buy side, and in most of my stocks, a big cash cushion to say fuck you with. Moreover, any management team that cares about its stock (and not all of them really do) will have a corporate broker who can tell them about the action in their stock, and identify when a price may be being manipulated. So presumably even the completely feckless managers the article posits, with a decent broker, could know a bear raid for what it was, and not let it put them off good ideas.

No, the truly pernicious effect of a bear raid is the diminution of the company’s ability, not its will, as the authors imply, to pursue profitable projects. Raiders are out to make more money than they deployed raiding the stock in the first place (duh), and the best way of doing that is to push it through technical support levels under which stop loss orders lurk, to trigger a cascade of selling. The trick with this is that, according to the technician’s handbook, support levels, once broken, become resistance levels, ie the stock finds it hard to break through on the upside except in the case of superdoubleplusgood news. Disgust and shame set in amongst the punters, who, having taken a bath in the stock once, and who sold at a loss, become much less willing to listen to the same spotty analyst telling them to buy it again.

For unless you believe in the pure Efficient Markets Hypothesis (and Goldstein and Guembel clearly do not), it is clear that stock prices can remain under their fair value for some time. It so happens that the very best time to mount a bear raid, if you really have the knives out for someone, is before an equity raising exercise, when the punters will be anxious anyway about the supply of extra stock coming on line. It also has the effect of reducing the amount of money the company can raise in the exercise, or increasing the proportion of the firm’s resources needed to take the project up, raising its risk. The company’s multiple can shrink, meaning it has to dilute shareholders more if it wants to raise a certain amount of money in the future. And thus its future prospects can be harmed.

The thing is, however, and from the writeup of the article I am not sure the authors emphasise this enough, organising a succesful bear raid right is really really hard, and very very expensive if you get it wrong, to the point you may, in extremely rare circumstances, even go to prison. You need very powerful and faithful friends to pull it off. A friend of Baruch has a favourite Asian technology stock, which is consistently the subject of classic bear raids, led most recently by Goldman Sachs, who put the stock to “super special sell” (Goldmans really does sometimes use a “conviction sell” rating), which was doing the bidding of an evil hegemonic competitor to the friend’s holding. This company at the same time was doing a roadshow with investors to discuss the perfidy of my friend’s stock. It was not a coincidence that 1) the competitor is also the source of a lot of potential investment banking business, and 2) the raid took place at a time when the target company was listing a spinoff on the HK stock exchange, raising money which would finance the leg up in its business (and from the evil competitor’s point of view, the next round of market share losses). The point is even with those powerful forces on their side, that those who joined in the raid, shorting the target and going long the competitor, would have lost a lot of money had they stayed in more than a couple of days. The GS sell side analyst who downgraded the target stock eventually lost her job, even.

This extreme difficulty in pulling off a raid is the single most important point why we should definitely NOT use the existence of bear raids to justify restricting short sales, as Goldstein and Guembel suggest we do. In most cases the raids just aren’t that effective, and, like firing a medieval musket, a bear raid is more a danger to the perpetrator than the target. Moreover, I don’t understand how manipulation only exists to bring down stocks, as the authors posit. This might just be because the writeup doesn’t summarise their ideas properly, if so I hope they forgive me:

we show that manipulation is profitable only via sell orders,” Goldstein and Guembel write. “This is because the two sources of profit behind the manipulation strategy … cannot generate profits with buy orders.” The speculator who has no special insight into the firm will assume it is less valuable than the market price reflects, so he has an incentive to sell rather than buy, they note.

Similarly, a speculator operating without any special knowledge produces inefficiencies likely to cause the share price to fall later. To profit on falling prices, the speculator must use short sales; he will lose money if he buys the stock.

I’m just not sure what that means. Wall Street and all financial markets, most of the time, exist to promote stocks, to make even the worthless ones go up. It’s a real conspiracy where governments, brokers, original investors, journalists and managements are complicit. It is more than possible to “raid a stock up”, ie engineer a short squeeze, and much easier than manipulating it down. Shorts are naturally more nervous than longs, and tend to have closer stops, ie their tolerance for pain is much less. Also, like Wildebeest would, they tend to huddle together for comfort in the same stocks, creating crowded trades. Killing the shorts is a game the whole family of stakeholders can play, from the management, who can announce a major buyback or otherwise manipulate their earnings to produce a big beat, to brokers who can upgrade, to major shareholders with more money than sense, who can “walk the stock up”, investing all that day’s inflows into the stock or otherwise marking it up at quarter end. The life of a dedicated short seller can be nasty, brutish, and er, short. The ones that are left tend to be extremely canny.

If the role of a stockmarket is to efficiently allocate capital, that will also, at times, tend to mean taking it away from those that have it. This is why we should bless the shorts, the raiders of stocks, and not be mean to them. For what Goldstein and Guembel fail to realise is that bear raids, if they stick, generally have something to them, some element of capturing a truth about a stock. I would wager more investors have been hurt by buying overvalued stocks than by buying fairly valued stocks that get raided. If they think raiding stocks is so easy, I suggest Goldstein and Guembel take the money they have made selling their paper online, and start a short only investment club. I really hope they let me know how it goes.


8 thoughts on “Bear Raid? Let me tell you about bear raids. . .”

  1. Thanks David, coming from you that means a lot. Thanks also for the link.

    Reading (or rather trying to read) the article was a bit of a shock. It’s a bit like the economist joke about a physicist, biologist and economist on a desert island with an unopened can of beans. The economist’s solution is to “posit a can opener”.

    These guys seem so far removed from the real world, it’s shocking.

  2. The concept of the “corporate broker” is foreign in the USA.

    The changing market structure (electronic anonymity, dark pools & crossing networks) has made the understanding of flow far more diffficult. Even large-holder filings can be skirted or are least delayed, all which works to the plungers’ advanatge.

    Even in the absence of technical stops, there are clearly times and places where sentiment, soon-to-emerge technical positions (feedback traders), potential supply from holders, exogenuous conditions, yield a an overly-pregnant situation that takes but the gentlest of nudges to get the stone rolling.

    Systematic strategies such earnings revision, earnings & price momentum, analyst recommend chgs and policy reactions (busted growth) are playing an increasing role in reinforcement of bear-raid-like strategies. While not the classical BearStearns/HBOS bear-raid, these former are far more prevalent, with similar outcomes.

    Most academic research has shown short-sellers (represented by measures of short-interest) generate excess returns over the medium to longer-term, and some recent work ferrets out subsequent news flow to posit they [shorts] possess informational advantage (better research?) if not material non-public information.

  3. What is embarassingly ivory tower is that, as far as I can see, the company they use as an example, Medizone, is a penny stock, total market cap $ 5m on a good day.

    Wish I’d gone to Cambridge now.

    Cassandra, can you link to the academic research which shows short sellers generate excess returns? Seems slightly counter-intuitive when most OECD markets have been rising for the past 25 years.

  4. Cassandra, do you mean stocks with high levels of short interest tend to underperform over the the medium to long term?

    Also we may have different definitions of bear raid — you seem to be describing occasions when a lot of shorts and sellers independently glom onto stocks, generally on bad news. For me a bear raid has to have some sort of narrower, collusive conspiracy angle to it, preferably without any actual news triggering the selloff.

    Of course, if the conspirators can manufacture some actual news in collusion with a competitor, regulator, or more likely a friendly broker, all the better.

  5. Baruch, Yes, precisely. In the shorter term, however I believe it is nebulous as structural SNAFUs (short-covering histrionics by low-pain threshold investors and/or ongoing manipulation whether upon historical accounting – e.g. accruals- or rose-coloured forecast cause much performance dispersion and pain). Overstock is perhaps the perfect example as Rocker&Cohodes suffered repeatedly from all of the above before “being right”, or at least vindicated by the market price of their position.

    We don;t have different defs. I was merely highlighting that “the market” and “the perps” are getting harder to distinguish, with the only one’s knowing for certain are the prime broker(s), one’s administrator, one’s auditor, and the plunger-perp himself.

    I would agree that the classical bear-raid is an art form, but in modernity, there are increasingly more mechanistic chain-like-reactions that can be discovered that are more similar to the classical in result than not. One can see examples of this at the micro-structure level where algorithms duel with each other to lower bids, spoof offers, canceling and replaceing bids in replies to others in a financial whirling-dervish dance that is as wondrous and absorbing to watch as ant colony’s at work. CXO has a compendium of summaries on short research until I gather my links for you.

  6. This what happen when the fundamental trend line have a disconnected price line. As long as the idiots do not know what they are stop ordering. The bears are raiding.

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