What are the hedge funds shorting?

0:05Pushkin The mood in markets right now remains decidedly wobbly. Stocks have generally had a pretty good year after some early shocks, but now, up at these heights, they're finding the air a little thin. The big worry, of course, is an AI bubble. Are we in one? And if we are, when does it pop and what happens next? Regular listeners will know we've talked about this a lot lately and, spoiler alert, we're very likely to keep on talking about it too. But today on the show, we're trying to find out what the supposedly smartest people in the room are thinking. Heaven knows that's not us. But we want to know, what are the hedge funds betting against?

0:48And what does that mean for the rest of us mere mortals? This is Unhedged, the markets and finance podcast from the Financial Times. I'm Pushkin. I'm Katie Martin, a markets columnist at the FT in London, where everyone is pretty nervous about this week's budget from the government. Hooray for us. But I have an unusual co-pilot today, Robin Wigglesworth, the editor of FT Alphaville, who, despite his very English-sounding name and pretty English-sounding accent, is actually half Norwegian, more than half, given that he lives all the way over there in Oslo. First of all, for our listeners who may not be aware, what is Alphaville?

1:26What is this thing that you edit? It's basically Nerdsville, right? Yes, that's a pretty apt description. but it's basically our finance blog so you know we dig into anything that's kind of weird or fun or interesting in finance economics business markets investing we can do kind of whatever we want whatever we want in any way we want so we try to have fun with it because i mean you and i know that this stuff is actually genuinely really fun and we try to maybe let that get reflected in how we write as well yeah exactly and there's an awful lot of nerds out there and like a proper nerd you are very excited that you've launched on sub stack this week what's that all about yeah that is actually quite exciting i mean alpha nville has had newsletters in the past but they've been kind of dare i say of simple half-assed efforts but this is something a bit more ambitious a bit more fun we don't really want to be beholden to you know maskinex or any other social networks we don't want to depend on search and frankie's is getting into people's inbox is a good way of of writing and talking directly to people.

2:30So some of that kind of worked well for us. And, you know, they have little video capabilities. We can start little forums there. We let people know about drinks, stews, pub quizzes, stuff like that. So it's kind of perfect and exciting. And most exciting of all, I don't have to write it myself. It's my colleague Bryce doing that. Just hoof it off to Bryce. Yeah, he gets us in so much legal trouble anyway. So I just figured just make him do it. Yeah, exactly. But listeners, if you are deep down a nerd and you wish to express that in your life, then there is a sub stack for you. FT Alphaville, very easy to find.

3:05Robin, so people who listen to this show are well accustomed to the thing that we do at the end called long short. So that's where you go long things you love and short things you hate. And we call it that because in the real world of markets, that's what hedge funds and other sort of speculative investors do, right? If they like a stock, they buy it. If they really like a stock, maybe they borrow money to buy loads of it. And maybe they even buy options that pay out loads of money if the stocks keep climbing. But if they don't like a stock, they go short. They bet against it. What does that involve?

3:39Basically, like two main things. One thing is short selling in that you borrow the stock rather than buy it and then sell it. You're actually selling something you borrowed. and if that stock then falls in value, well, you can buy it back and return it to the original owner and pocket the difference, essentially a profit. So if you borrowed something at$100 and it drops to$10 and you sell it at$100, it drops to$10, you buy it back at$10 and hand it back to the original owner at the$10 value and you've made$90. Another way is doing it through options. So we talked about like calls, this type of option that, you know, you gain upside exposure You can also buy puts.

4:20So that's the right to sell a stock at a certain price if it drops enough. So you can just bet that the value of this thing is going to fall. And if you make money out of it, happy days. Happy days. But it's a risky old game, isn't it? It's not for the faint-hearted shorting stocks. Because if you short something and it goes up, you get annihilated. Not for the faint-hearted. But what is going on? What are hedge funds, you know, kind of like speculative investors? What sort of shorts are they taking out on the US stock market at the moment? Well, the positioning data for hedge funds on short selling is a little bit iffy sometimes, but we do get these little snapshots here and there.

5:00Goldman Sachs has a big prime brokerage. That's the desk that is like a concierge service for hedge funds. And they collate a lot of this data. And it was really interesting seeing the latest snapshot, which indicated that, look, hedge funds are still not kind of really putting on the big short on AI quite yet. As you point out, you can get absolutely destroyed if it goes up against you because if you buy a stock, worse thinking here is zero. You lose all your money, but that's it. If you're a shorter stock and it goes up, there's no limit to your losses. You can lose an unlimited amount of money in theory.

5:36So it is a dangerous thing. But now they seem to be dabbling around the edges of the AI bubble. Yeah, they're nibbling, aren't they? Yeah, just kind of testing things out. Maybe a few of the weaker companies in the AI hyperscale of the game. Yeah. Or few companies that are benefiting from it, sort of AI adjacent stocks. Yeah, so I was looking at the post that you wrote on this the other day over at Alphaville. So about 2.4 % of the overall value of the S &P 500 index, that's the kind of big index of US stocks, that's currently short effectively. And that's a lot relative to the past five years.

6:12And it's well above the average that we've seen since 1995. But as you say, they're not shorting your kind of NVIDIAs and Apples and Amazons of the world. Although if you shorted Meta recently, you would have made quite a lot of money out of it. So as you say, they're kind of looking more around the edges and being a little bit cleverer than that. So what sort of companies are they betting against? Well, in the AI boom right at the center, but sort of maybe not like a Microsoft or Meta or Alphabet, but those kind of stocks, Oracle, is kind of seen as the weak one of that herd. I see. So it's a big, valuable company, and people aren't sort of going crazy shorting it, but we can definitely see short interest as a measure of like how many shares are out on loan has been creeping up for Oracle.

6:59We've also seen people buying something called credit default swaps on Oracle debt, which is an interesting way of betting against a company's bonds. It's credit worthiness. So just to do a little kind of freeze frame on credit default swaps, these are accursed words. You never want to hear about CDS in relation to anything, ideally, because, listeners, I won't bore you with the details, but they are ways that investors can bet against the debt of certain companies. And they were absolutely at the center of the drama like a decade and a half ago or so with relation to the Eurozone debt crisis.

7:36so investors were buying CDS so buying insurance contracts that would pay out in the event that a member of the euro defaulted on its debt which is terrible, terrible, no good awful thing to happen and you kind of got in these situations where the CDS contracts were kind of the tail that wagged the dog and they were effectively helping the bonds to fall in value and then people bought more of the CDS and it was an unholy mess and I haven't heard the letters CDS in relation to pretty much anything for quite a long time. So the fact that they're back in relation to debt from technology companies is just not a fantastic sign.

8:15But the levels aren't that high on the CDS, right? Nobody thinks really that Oracle is going to default. No, it's more of a bet on Oracle's credit worthiness dropping, not dropping like a rock. Nobody's betting that Oracle is going to go bankrupt or anything like that. But it's just a snazzy way for credit hedge funds. Those are hedge funds that deal more with bonds and fixed income rather than stocks to bet on or against the AI bubble. And Oracle, just as the kind of the weaker one of the herd, is the one that people are maybe sort of circling around a little bit and keeping an eye on. Yeah. Just to stick on the issue of debt for a little bit, I was reading a piece from the Swiss bank UBS the other day.

8:56They had a note out, I'm pretty sure it was from Matt Misch on credit. And he was saying that issuance, so that the amount of debt that's coming from companies in the tech sector has absolutely rocketed. So in investment grade debt in the States, that's kind of safe corporate debt. The amount of it that's coming from technology companies is up by 80 % this year. And similarly, there's been a big jump in the amount of private credit that's coming from technology companies. So it's not just in stocks where you can see all this kind of fizzy AI excitement. Just the amount of new debt that's coming to market from tech companies is absolutely mind-blowing.

9:36Does that worry you at all? I think it's a symptom of this underlying frothiness. These are companies largely that are still wildly profitable, have very little debt already. That's why it's kind of notable that Meta and Amazon and Microsoft don't really issue that many bonds, if any. So despite them, I think, issuing last time I checked over$300 billion worth this year to finance data centers primarily. For those companies, that's still only, you know, it's easy covered by their cash flow. Yeah. But it is interesting just that it kind of displaces everything else, right? it's like this big fat elephant walked into the bond market squatted and kind of starts commanding attention for everything else so you can easily see knock on impact on other sectors that suddenly have to compete with meta bonds in a way they never had to before yeah scary stuff yeah also from the from the ubs note they were saying ai data center and project finance deals are estimated to have increased tenfold this year to at least$125 billion.

10:44That's an awful lot of techie debt kicking around. So going back to the stock markets, you know, as you say, it looks like hedge funds are taking quite a quizzical look at Oracle. But they're also betting against some quite obscure smaller companies in weird sectors like utilities. Explain to normal people why utilities get caught up in the mix here. Well, that's what I thought was the most interesting in this recent Goldman Sachs report. It showed that there's never been more short interest against US utilities since at least 1995. Really? I think is how far the data goes back. And, you know, utilities are kind of, by design, they're kind of boring.

11:25They should be boring. You don't want a utility to be exciting and racy. So there's very little short interest in utilities normally. the reason that has changed is that, of course, as much as AI requires data centers to run, data centers require power, a lot of power. So a lot of utilities have been investing tens, sometimes hundreds of billions of dollars in new energy projects to fuel these data centers. They've seen their stocks rise in tandem with the AI excitement. But the danger is, of course, that some of these utilities borrow money and bet the farm on AI and then are left holding the bag when it actually turns out that this isn't that data intensive, that they've built all this infrastructure that they can't really pay for in the future.

12:14So that's why we've seen a big spike in short interest in utilities. And it just feels like markets are sort of swirling around the plug hole a bit, sort of kind of waiting to get sucked down into the abyss, right? There is just this sense that they've had it too good for too long. And it feels like, you know, we don't necessarily get a crash in AI stocks, which, you know, to be clear, would like nuke the entire market for a pretty short period at least. But everyone's kind of dancing around this sort of bubble theme and wondering, when does this get dragged down and what will make it get dragged down?

12:55I mean, your guess is as good as mine, which is as good as anybody else's. What do you think is going on here? What do you think people are waiting for before this correction, if there is what really takes hold? I mean, I have no clue, but really when the correction actually starts. The reality is that hedge funds, at least the smart ones, don't want to bet against the bubble whilst it's still inflating. You'll get run over. You wait until it actually is already collapsing and then you pounce on it, essentially. I mean, most hedge funds are still YOLOing into technology stocks and AI stocks in general.

13:28They are still massively long NVIDIA and all the other AI companies. And that hasn't really changed. What is changing is that you can see they're starting to map out a playbook of what they might start doing when eventually things do crumble. Because we know they always do. And it might be next week, it might be next month, it might be next year, or maybe in five years, we don't know. But you can see that where they think the most carnage is going to fold are all these sort of AI adjacent sectors like energy companies, utilities that are kind of frankly probably boring, investing too much money to service something that might end up proving a bit of a mirage.

14:11Yeah, yeah. So we're not there yet, but we're maybe seeing the early contours of the first playbook, as it were. Yeah, the contours of a playbook. I mean, you know, this is very much the kind of bread and butter of what you guys do over at Alphaville, isn't it? It's like that little tagline, you know, this is nuts, when's the crash? Yes. It's the question that keeps coming up in Alphaville Post, but it does feel like you've been asking it for a long time. Like, when is the crash? Like, what are you going to write about when that actually happens? Yeah, there's a reason why we're financial journalists and not bazillion sitting on a Caribbean island by ourselves counting our massive stacks of money.

14:48Quite often people will point out that we are irredeemably cynical and sceptical of everything. We're saying, where's the crash? since I think the first time 2013. The advantage of being a journalist that we have no skin in the game will be proven right at some point. And then we'll try not to be too smug about it because frankly, everybody else is still richer than us. Yeah, yeah. But it does feel right now that things have gone a little bit nutty around AI. And even if you believe that it is transformational, even if it does prove transformational, Prices can still be stupid. Yes. And people forget that dot com, everything was right.

15:29Everything that people said in 1999 was completely right. But people still lost an ungodly amount of money in the years that came afterwards. Yeah. So in that sense, it is a little bit of a warning sign that people are starting to put their money where their mouth is and bet against some of the kind of, you know, shakier bits around the edges of the AI trade. I mean, do you have a good sense of whether it makes sense to watch what hedge funds are doing? Are they the smartest people in the room? And do they tend to move first in terms of, you know, picking market direction? Or are they just as lost as the rest of us?

16:08It's a good question. I'd say that individually, they are incredibly smart. Like they can be wrong, but they are very smart. They have dedicated every little atom of their being to understanding and beating markets. And they struggle to do it quite often. As a group, no, they do not tend to have a lot of sort of presence when it comes to these things. They move as a herd, just like mutual fund managers do, and just like they traders do as well. Yeah. So, you know, they get stuff wrong. There are times when hedge funds are unduly negative or unduly positive and the proverbial dumb money, the you and me money is farther.

16:47Yeah. But over time, you know, they can suss out problems pretty early. And this is why I think we shouldn't look to them to understand the timing of when the AI bubble might burst, but more to understand how it might start playing out. And right now they're saying the main damage is not necessarily going to be in Meta and Alphabet and Microsoft and NVIDIA, which have solid, very profitable businesses, even if AI went away tomorrow. it's in all the adjacent companies and maybe some of the AI has-beens but the second - The hangers-on Yeah, hangers-on that are trying to basically borrow and spend as much money to become meaningful players of what they think is going to be a massive transformational industrial shift.

17:36Yeah. Those are the ones that think are going to get hammered in the downturn that comes at some point. So as we've been saying short-selling is hard it's very hard to get it right. One of the more famous people in the world who has sort of done this for a living is a chap called Michael Burry. Tell us about him and what he's up to. Well, Michael Burry first rose to prominence as one of the few people that sort of bet against the housing bubble in 2008. He was immortalised in the book, The Big Short, by Michael Lewis that was later made into a film, one of the racy films made about financial crisis that I can remember seeing.

18:11And because of that, he's kind of, because he's such an idiosyncratic character, he's very single-minded, he's become a kind of a celebrity. Yeah, he's got cult status, right? Exactly. And he's mysterious and inscrutable online. He's got like a massive following on X. And I'd say like, I mean, reality, he is a good example of how hard short-selling is. because although he made an absolute fortune in 2008, a lot of the stuff he's tried to do since then hasn't worked out in the same way. It's just very hard being short, a marker that, generally speaking, does go up. And he tried to put on the short, or he put on the short, it seems, on Palantir and NVIDIA earlier this year until in the end he just threw in the towel and then he closed his hedge fund.

19:02He couldn't be bothered anymore. So he set up a sub stack, which seems to be letting in anybody these days. Yeah. So, Wigo, thank you so much for sharing your brain there. As you say, us journalists, we may be poor, but we do have more fun than those terrible finance people. I am also, I have personal experience of being short. Firstly, from the point of view that I bet against micro strategy, you might remember, in last year's stock picking competition, and I got killed. And also, I'm short in the sense that I'm only five foot two. So take pity on me. but Wiggo thank you so much listeners if you are into that sort of stuff shorting and the guts of financial markets and all of that check out FT Alphaville in general and it's new Substack in particular Robin you've been a gent thank you so much we're going to be back in just one sec with Longshore

20:05Okie doke, it's time for Long Short, that part of the show where, as for the rest of the show, in fact, we go long a thing we love or short a thing we hate. Wiggo, what are you saying? Well, I don't hate it, but just given the theme of this pod today, I thought I'd go short. I go short the most heavily shorted stock in America, in fact, a company called Bloom Energy that makes fuel cells for data centers. And it doesn't actually make a lot of money. I think it's forecast to make maybe$100 million next year. And it's valued at around$30 billion. It has been very heavily sucked up and amped in this whole AI frenzy to kind of preposterous levels.

20:49And although I'm slightly worried it's a very crowded short and they can be quite dangerous as we saw with GameStop a few years ago, I just think like this is nuts. There will be a crash at some point. So Blue Menage is my short. Okay, listeners, this is not investment advice, and we are terrible at this. I am short the crypto maxis, because I had a little bit of a dig at crypto in my column the other day, and they didn't even really email to say how much they hate me like they normally do. And I thought, these guys are a bit off their game. So I'm not saying please do email me your usual flood of abuse.

21:26But I am saying, you know, you're okay, hun. Like they have gone a little bit quiet. now that Bitcoin has taken a bit of a step back in price. Robin, again, thank you so much for being with us today. All of your internet issues notwithstanding. Listeners, this show is produced and edited by our friends at Pushkin in the US and they are, of course, out for Thanksgiving Thursday. So we are going to be back next week. If you're in the States, have a lovely holiday and wherever you are, listen up when we are back in your ears on Tuesday. Unhedged is produced by Jake Harper and edited by Brian Erstad.

22:02Our executive producer is Jacob Goldstein. Topher Forhears is the FT's acting co-head of audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn and Natalie Sadler. FT premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Katie Martin. Thanks for listening.

22:32We'll be right back.