Wednesday, 22 May 2024

By Callum Newman Editor, Small-Cap Systems and Australian Small-Cap Investigator

[3 min read]

Dear Reader,

Every now and again someone in the financial world lets slip with a key insight on what you want to find on the stock market.

You’ll see that below in today’s Fat Tail Daily.

In comes via an unlikely source – one of the least liked figures in the Aussie market.

In other words, a short seller.

You probably know the term.

These guys are the cynics and sceptics that look to profit from a share the opposite way to the rest of us.

Yep…

They’re always on the hunt for shares that are likely to go down…in a big way.

You and I want to own shares with rising sales, growing markets and expanding margins with great management.

Short sellers want to see, in some combination, declining audiences, falling profits and an incompetent executive team, preferably in a declining industry. 

Short sellers want to latch on to all this before it’s obvious to the market…and built into the price.

Why are short sellers unpopular?

For the same reasons a lot of analysts don’t like slapping a ‘SELL’ on a stock.

You’ll likely get someone from that company, or a devoted shareholder, that takes great offence to the idea that their stock might be overvalued, losing market share or likely to get dumped.

Some people go as far as to say short selling should be banned.

I don’t agree.

The shorts have a great role to play in the market. These guys are incentivised to stress test companies in a way only a big financial incentive can bring.

Short sellers have exposed some of the biggest corporate scams in US history. Enron around 2000 springs to mind.

It’s happened here in Australia too.

A few years ago, a short fund targeted a popular stock on the market called Blue Sky Alternative Investments.

Here’s the truth: the short seller was vindicated. Blue Sky’s valuation and credibility collapsed, and quite rightly.  

Yes – investors got burnt. Perhaps they should have done more homework.

For the rest of us, a dud was cleaned off the market, and future investors spared wasting their time and capital.

Here’s a point: short sellers don’t get it all their own way. They take huge risks.

You see…

When you buy a share, the very worst outcome is it goes broke. You can lose 100% of your investment.

That’s not good, but you know that’s the limit to your liability after that.

A short seller faces, at least in theory, unlimited risk because a share can keep rising and rising and rising.

Think of the brave and (in hindsight) foolhardy types that went short on Tesla or Afterpay over the last decade. Or Gamestop more recently…

These companies smashed the shorts because of their astonishing rise.

This is why I found the following comment from Aussie short seller John Hempton so intriguing.

The Australian Financial Review profiled him and his fund recently, and Hempton said the following, when it comes to short selling…

‘I am very scared of the fat tail.’

A ‘fat tail’ is an outcome that exists on the edge of a normal distribution curve.

It’s the kind of low probability, high impact action that results in a dramatic result.

Tesla and Afterpay were originally dismissed as overhyped, money losing, obscure industry players with unclear competitive propositions. A short seller’s dream, in other words.

It turned out they were disruptive, unstoppable forces – at least for a while – that forged new, significant niches in their sector.

Both returned their original investors many multiples of their original investments.

They smoked their early shorts as well…and why Hempton says he lives in fear of fat tail firms like those two.

A big, uncontrollable move up against one of his short positions can cost him millions. 

Here at Fat Tail Investment Research, we love a ‘fat tail’ as much as it terrifies him – hence our name!

We don’t particularly care about short sellers, either way. 

But we want to find the type of firms that can break through a consensus viewpoint and deliver exciting benefits for our subscribers.

One my recommendations is doing that right now…Nuix Limited [ASX:NXL].

It skyrocketed over 20% on Monday…and is now up over 200% since around this time last year when I first made the recommendation.

It, too, was a target for short sellers at one point – probably deservedly so at that.

But the wonderful thing about the share market is that a company can redeem itself, as long as it stays alive through the tough times.

Yes…Nuix had an appalling start to life as a listed company on the ASX. The price collapsed 90% at one point.

A year ago I surveyed the wreckage…

‘What if this situation can be salvaged? What could turn it around? Is this a total turkey or is there a hidden asset here?’

Yes, was the short answer. But I didn’t know that then.

What I knew at that point was that Nuix was so hammered, so hated, and so crushed…that there was clear – and big – upside if they could turn it around over time.

A potential fat tail idea, in other words.

And Nuix have turned it around – at least so far. We’ll see how it goes over the next year. There are no guarantees here, and big risks remain.

But it’s a reminder that outsized returns – and risks – can only come from doing something outside the consensus.

If everybody thought Nuix was brilliant in 2023, there was likely little profit in buying it. That perspective would be in the price already.

Right now, you have the opportunity to act on artificial intelligence in the same way. Everyone throws around the same names that benefit…NextDC and Goodman Group, being two prime examples here.  

Both of them make sense. But they’re so well-known now it’s hard to see the immediate upside.

No…to play the AI thematic you need to think about lesser known, less well priced ideas.

I can’t guarantee these ideas will be right…but if they work…the benefits could be exciting.

John Hempton is scared of fat tail ideas for a reason.

And while not all stocks will perform like Nuix…

…the opportunities can be worthwhile when they work. Nuix is proof of that in as little as a year. Who knows what it might look like in five?

For my 5 ‘fat tail’ ideas on AI, go here now.

Best,

Callum Newman,
Editor, Small-Cap Systems and Australian Small-Cap Investigator

Callum Newman is a real student of the markets. He’s been studying, writing about, and investing for more than 15 years. Between 2014 and 2016, he was mentored by the preeminent economist and author Phillip J Anderson. In 2015, he created The Newman Show Podcast, tapping into his network of contacts, including investing legend Jim Rogers, plus best-selling authors Jim Rickards, George Friedman, and Richard Maybury. He also launched Money Morning Trader, the popular service profiling the hottest stocks on the ASX each trading day.

Today, he helms the ultra-fast-paced stock trading service Small-Cap Systems and small-cap advisory Australian Small-Cap Investigator.

By Bill Bonner Editor, Fat Tail Daily

[3 min read]

Dear Reader,

Our wonder for this week is how an economy... said to be the finest the world has ever seen...  

... with capital in abundance... talent and skills drawn from all over the planet... more PhDs and engineers than ever in history...  

... and guided by the geniuses at the Fed and in the Capitol...  

... could be such a dud. 

Unlike the US economy up until 1975... and unlike the Chinese economy 1979-2024... it has not improved the lot of the typical citizen. 

This is not to say that the median person is not better off. Today, for better or worse, we have electronic gizmos that we didn’t have in the 1970s. We can spend our whole lives hunched over our laptops... perhaps sitting in coffee shops or a basement office... playing games... and talking to undressed women with Russian accents. Is that progress, or what? We have TikTok, Facebook, X... AI... cryptos... Trump sneakers... We even have cars that will create their own traffic accidents. No human intervention required.  

In 1914, Henry Ford doubled wages in his auto factory — to $5 a day. A job at Ford was a ticket to middle-class prosperity. Detroit became the most prosperous city in the country. 

But workers in our new industries today, including those of our biggest employers, often live in shocking poverty. At least, that was the conclusion of a study done of Amazon’s warehouse staff: 

‘In this report, we present findings on economic insecurity among Amazon’s frontline warehouse workforce, drawing on a national survey of 1,484 workers across 451 facilities in 42 states. Key findings include: 

‘53% OF WORKERS EXPERIENCED ONE OR MORE FORMS OF FOOD INSECURITY in the previous three months. 

‘48% OF WORKERS EXPERIENCED ONE OR MORE FORMS OF HOUSING INSECURITY in the previous three months. 

‘MORE THAN HALF (56%) HAVE NOT BEEN ABLE TO PAY ALL THEIR BILLS without a remaining balance in the previous three months. 

‘ONE-THIRD OF WORKERS (33%) HAVE USED ONE OR MORE PUBLICLY FUNDED ASSISTANCE PROGRAMS in the previous three months, including 23% who have used the Supplemental Nutrition Assistance Program (SNAP).’ 

Let’s see... at $5 a day, a Ford assembly-line worker was able to buy a $20 US gold coin every four days. (We use gold as a reliable measure of inflation.) 

Today, a warehouse worker at Amazon makes $17 per hour... times 8 hours, equals $136 per day. With the price of a one-ounce gold coin now around $2,300, this means it takes more than 16 days — or four times as long — for today’s worker to buy the same coin. What gives? What’s wrong with America’s economy?  

Today, we will not let the cat out of the bag, completely... but we will open up the bag and take a peek inside. 

We saw yesterday that the Soviet Union took raw materials and following the logical precision and dumbass theories of its planners, worked them up into finished goods of such inferior quality that they were actually worth less, on the world market, than the resources that went into making them. 

Death by Government

That is why, when the Soviet Union went to Misguided Economic Experiment heaven, its entrepreneurs and oligarchs went back to producing raw materials. 

The Hitlerian economy of Germany 1933-1945 was a similar success. It put people to work. It made the trains run on time. It made the smokestacks from Bavaria to Prussia belch smoke. But what it produced — guns, tanks, chemicals and bombs — did not make people better off. It made them worse off. 

In each case, you’ll notice the causal relationship. The government imposed its will on the economy... turning it away from producing the things people wanted... to producing the things insiders wanted. 

And the US? It began its Misguided Economic Experiment in 1971. Thenceforth, it continued to be a powerhouse of output. But the output shifted... subtly... almost unnoticed... from the goods and services that made people wealthier and better off... to an ersatz form of wealth itself. Wall Street got rich (after 1982). Detroit got poor.  

The shift was a spectacular success — for some. Unfortunately, it was a dismal failure for most. 

Up until the mid-‘70s, the wealth of the rich and poor rose... together. At more or less the same rate. Then, they began to diverge... little by little at first... and then by a lot.  

From our friend David Stockman: 

‘Since 1989... the net worth of the top 0.1% has soared from $1.8 trillion to just under $20 trillion. That’s a gain of $138 million per household.  

‘By contrast, the aggregate net worth of the bottom 50% or 66 million households has risen from $0.7 trillion to $3.6 trillion. That’s a gain of just $44,000 per household. [Mostly from an increase in house prices.] 

‘Accordingly, the top 0.1% gained 3,100X more net worth each than the bottom half of America’s households.’  

So we see, the US economy was not a total flop for everyone. But something went very wrong. 

Tune in tomorrow as we look at our hypothesis: another Misguided Economic Experiment gone wrong.

Regards,

Bill Bonner,
For Fat Tail Daily