Odd Lots - Jim Chanos on Why Some of the Worst Hit Parts of the Market Still Have More Pain Ahead

Episode Date: June 16, 2022

Legendary short seller Jim Chanos says that despite the plunge in stocks, there are numerous swathes of the equity market with plenty of downside risk. On this episode, the Chanos & Co. fund manager, argues that the market overall has simply not internalized what sustained higher rates will mean to business models and valuations across a variety of sectors, including real estate, utilities and consumer packaged goods. He walks through the various excesses that we've seen over the last several years, and why investors are all paying the price for them now.See omnystudio.com/listener for privacy information.

Thanks for listening to OddLots. Follow the show on Amazon Music for more future episodes or just ask Alexa play the podcast, OddLots on Amazon Music. Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive, murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day. But not Vanguard. At Vanguard, institutional quality isn't a tagline. It's a very big. It's a firm. It's a firm. It's a few. It's a few. a commitment to your clients. We're talking top grade products across the board of over 80 bond funds, actively managed by a 200-person global squad of sector specialists, analysts, and traders. These folks live and breathe fixed income. So if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com

slash audio. That's vanguard.com slash audio. All investing is subject to risk Vanguard Marketing Corporation distributor. Visit Don Valley North Lexus for interest rate reductions of up to 3% for lease and finance rates, resulting in lease rates as low as 0.9%. Plus, delivery credits of up to $1,500, only until April 30th. Visit dawn valley northlexis.com. Hello, and welcome to another episode of the Oddlots podcast. I'm Joe Wisenthall. And I'm Tracy Alloway. So Tracy, obviously, numerous assets across the market have been crushed. But, you know, one of the things, you know, math says that something could go down 90%, and it actually could go down another, and it could go down another 90%. It could go down from there.

So there is this question of like, well, is there real value at some point that's going to emerge out of this rubble, or is it really just a lot of trash that's going to zero? Yeah. The thing that kind of worries me when it comes to valuations is, you know, people talk a lot about the pawns enomics of things like. of things like cryptocurrencies, but then, or just the idea that the only value they get is by money continuously flowing into them. But then I worry that you could make that case for a lot of traditional assets as well, stocks and bonds, right? So we've just seen valuations go up and up and up, seemingly without limit, which kind of means that on the downside, maybe they can go much further than you would normally think. Well, and I guess the question too is, you know, like

cryptocurrencies aren't bolstered by like, oh, well, free cash flows or like some sort of cash in the bank that eventually makes it valuable. But in a company, you know, the question is, do the unit economics work? Sure. Is there an actual business model? So you can have money losing companies that might still be worth something because there's like a business model there to be salvaged. But if you get a lot of companies that really in no economic conditions, whether it's boom times or busts, have something that is actually a business model that could be turned into something. can generate cash flow, then right, you can get into the situation which the only reason they were going up is because of investor money. And when that's gone, perhaps the assets are worth zero.

Yeah, exactly. And it just feels like there's so much uncertainty at the moment. And of course, the big wildcard is the backdrop of inflation, which we haven't really had to deal with before, right? Normally, if things started going a little bit weaker in terms of the economy, we would expect the central bank to step in and do something, you know, provide some support. And that would lift valuations up once again. That doesn't seem like it's going to happen this time around. That's a very new dynamic and it wasn't even in place. You know, obviously in 2008, 2009 when there was an aggressive response to the downturn. Anyway, enough of our talk, because I'm really excited about our guest, someone who knows a lot about the state of the world

valuations, whether assets are cheap or whether it's just more Ponzoomics all the way down. We are going to be speaking with Jim Chanos. He is the co-founder of Chanos and company which used to be called Kinnikos. He's probably one of the most famous hedge funders slash short sellers in the world on Wall Street really needs no introduction. So let's bring him straight in. So we just did one.

I know. Jim, thank you so much for coming on outlets. I don't think we've ever had you before. So this is a real thrill to have you on. Thanks for having me, guys. But I would say that being a famous hedge funder or even were short seller is a pretty low bar these days. Well, so you're saying,

something that has really stuck with me for the last two years. And I want to start the conversation here. You know, it was summer 2020. And the stock market after plunging in March had started surging and people really going into a lot of these like sort of like internet companies and like ubers and grubhubs and all of these, you know, tech companies that recently IPO. And you said something interesting. You're like, if they're not making money now, and I don't remember your exact words, But you said, if they're not making any money now, when all of us, so many people are stuck home, ordering online and so forth, if they're not making any money now, when are they ever going to make money, if not in the beautiful, perfect economic conditions of everyone in summer 2020, buying so much online? Is that still the case? Like, have any of these companies made any progress to having a business model? So the companies we were talking about were some of the gig economy darlings in 2020.

and continued to be so in 2021. And we like to drill down not only in the financials of the business, but also the business models and to see if they make sense. And what became pretty apparent to us in a number of them, particularly some of the well-known companies like Uber and Lyft and DoorDash, which came public later, is that the UNET economics were terrible. And not only that, they were terrible. at a time when they should have been nirvana, as you point out, for example, food delivery,

when everybody was getting checks from the government and stuck at home. And restaurants were going out of their way to make delivery, you know, acceptable and easy. And yet the food delivery company still couldn't make money because there were just too many people without stretched hands earning fees. And so, you know, it got to the point where narratives, by 2021, the first quarter of 2021, which was sort of the peak of the craziness, narratives trumped everything. And if you had a story and you could spin it about, you know, future size of market and profitability by 2030, you could go public, you know, do a SPAC. And unlike the dot-com era, where those kinds of sort of pie in the sky stories had, you know, two, three, four, sometimes five billion

dollar valuations. In this case, they had 20, 30, 40, sometimes even 80 billion dollar valuations. And that's why we sort of called it the dot-com era on steroids, because we're setting aside the profitable companies, you know, the sort of legitimate Silicon Valley companies. I'm talking about the stuff at the end of the whip. And, you know, that's what was sort of shocking to us was just how big people were paying for the, you know, in effect, the option value that the business would be worth something, you know, possibly someday, even though the business model was certainly unproven in 2020 and 2021. And that's to us probably the most striking part of what happened in the markets in Silicon Valley. versus, say, 20 years ago. So one of the things about being a short seller is that it can also, it can often be a fraught,

emotional experience for many, many months and even years until your sort of proven right or the market turns your way. So I'm curious, what have the past few years been like for you, you know, watching some of these companies that, you know, aren't generating earning? Some of them aren't even cash flow positive. and seeing them attract loads and loads of money. And then how are you feeling right now? Because it does seem like some of the errors getting kicked out of the valuation tires of these companies

that you have long been criticizing or targeting. Yeah. So really what happened, the sort of Rive of the Valkyries of the Short Side was sort of kicked off when Powell reversed course at Christmas of 2018. You remember the markets had gone down almost 20% and high yield was ticking up. And they were tightening gradually and completely reversed course. And by the way, the real GDP was roughly 2% in the fourth quarter of 18 and 2% in the first quarter of 19. There was nothing going wrong with the economy.

But he blinked. And that turbocharged the markets in 2019. And then with the pandemic, you saw just the unprecedented, both monetary and fiscal support. And also, I would point out in the fall of 2019, when we saw widespread reduction in retail commissions, if you remember, everybody went to zero commissions. And you had the advent of Robin Hood and Ameritrade and Schwab, all advertising. And that's when we saw retail begin to pour into the market. Prior to that, for the 10 years of the bull market from 2009 to 19, retail was basically buying, you know, index funds and ETFs and basically, you know, sort of investing reasonably. But starting in the fall of 2019, everybody decided to pick stocks and buy options.

And you can see it in the price chart of, say, Tesla or whatever, the high flyers really began to go in October of 19. And, you know, they took a speed bump in March of 2020 with the pandemic, but as soon as the Fed opened the spigots, it was back to the races. And it really went on until sort of the first quarter of 2021, which was a period unlike anything, you know, I've seen in my 40 years of being on the short side. It was the meme stocks. But what was really striking to me was the fact by February of 2021 for a couple of, week period, new SPACs were raising, new SPACs were raising on average 3 billion in cash every night. And that was equal to the U.S. savings rate. So for a brief period of time, SPACs were taking the entire U.S. savings rate, which just struck

me as the height of absurdity. And so, you know, most stocks peaked out in that first quarter, first half of 2021. And, you know, our performance hit its bottom there and really began kind of climbing in the summer of 2021, even though the market made a new high in the fall. A lot of stocks began to falter. And then we saw in our portfolio, and I think overall we began to see disasters, things like Peloton and Robin Hood and Draft Kings. And, you know, stocks that were suddenly, darlings were suddenly down. 50, 60, 70% on perceived, you know, bad news. And that was before, that was, you know, as the market was peaking in October, November. So some of these gig economy companies that you mentioned in the

beginning, they're unit economics. They just didn't work too many fees, even under the best conditions. You know, some of those names you just mentioned, like a Robin Hood, Peloton, etc. Like, how do you think about any value for them now? Because it doesn't seem like, in theory, that it should be impossible for Robin Hood. I mean, I guess they don't charge fees. So maybe that is tough. It doesn't seem like it should be impossible for those to be viable businesses. Like, at what point, I guess, like, how do you think about how far this could go?

Well, I mean, like anything, we look at, you know, we look at what is our upside and downside and try to structure. our trades accordingly. But, you know, for a money losing, a money losing financial generally trade slightly below tangible book value. I mean, that's where the Chinese banks trade. That's where the European banks trade who are profitable. But people don't trust the numbers and trust the model long term. So I would say that, you know, some of the money losing brokers like Coinbase or Robin Hood, or some of the FinTech companies, which was another absurdity, foisted on the market in 2020 and 2021, you know, those stocks are going to probably trade below book value, slightly below book value. And for some of these companies, that's a long way down.

Do you think something changed in terms of fundamental investor behavior that allowed us to get to the 2020-2020 point? Or is this just what we've done? seen before, I mean, most notably with the tech bubble, like we can have instances where valuations go absolutely crazy, or did something actually happen that makes this period unique in some way? I think there's a, Tracy, I think there's a confluence of events. If you remember that in the tech bubble, it was primarily tech, right? There were a lot of value stocks that actually held up pretty well in the ensuing bare market.

It's where a lot of hedge funds made their reputation, for example, being short the garbage and long value in 1999 to 03. And so you have this one pocket of insanity based on a narrative, the Internet, and everything else was kind of, you know, reasonably priced, given where rates were and the economy. And remember, the recession we had in 2001, 2002 was pretty mild. It was a business-driven recession. It didn't really affect the consumer at all. And so this go around, it's almost everything. And that's what's so interesting. You know, it was not only technology, but think about things like cap rates in real estate, you know, down at 3% and 4%.

And crypto and NFTs and just a wide variety. I mean, I still have lots of shorts in my portfolio where the companies are barely profitable and they're trading it at, you know, 30 times. cash flow and 40 times cash flow still, even after the decline. And I think that the one thing that people are not prepared for is interest rates resetting meaningfully higher because it hasn't happened in most investors' lifetime. I came on the street in 1980, just as rates were peaking. And so the idea that actually interest rates are not going to be two or three percent for the foreseeable future is going to be hard for a lot of investors to deal with if we go back to what I would think would be more reasonable rates based on what we're seeing in the economy and inflation and whatever. This market will not be able to handle five or six percent 10 year. I mean, just won't.

And so many business models that we look at are just extremely low return on invested capital because capital's been so plentiful for the last, you know, 12 years. Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive, murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day. But not Vanguard.

At Vanguard, institutional quality isn't a tagline. It's a commitment to your clients. We're talking top-grade products across the board of over 80 bond funds, actively managed by a 200-person global squad of sector specialists, analysts, and traders. These folks live and breathe fixed income. So if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com. That's vanguard.com slash audio.

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Go to FactorMeals.C.A. and use code fit. That's 11 meals, free shipping, and free sides for life, but only with the code fit at factoramills.ca. Canada's number one ready-to-eat meal delivery service. You mentioned the fintech, you mentioned the gig economies. When you look at just terrible business models or business models that can only possibly survive under the cheapest, most abundant capital, what else is out there that looks egregious?

I mean, there's almost the whole cross-section of reeds just seems absurd to us, that you're going to be buying, you know, apartment buildings at a 3% cap rate. That's before capital spending. That's pre-tax. with the tenure at 3.30 today. I mean, this just makes no sense. And office buildings and warehouse. I mean, just go across the board, data centers. I mean, it's just, it is, we've gotten so used to feasting on these ultra-low interest rates that I don't think people realize, you know, where equities will trade in a resetting market where risk-free rates are four or five percent.

And I think that's a big area, even things like electric utilities and consumer package good companies. I mean, these things are all still trading at 25, 30 times earnings. And I think that they've been seen as defensive because they're not technology. But at this point, they may have as much risk as the tech tax. So, you know, I hesitate to ask you for a price target on the S&P 500. But could you give an indication of how low you think things could go? And also, what do you think is the most overvalued at the moment and the most vulnerable to higher rates? I mean, I'm long of the S&P 500 in my hedge fund, just FYI.

Right. So, yeah, so we're long the broad market and short, short our radioactive sort of group of companies. So just get that out there for full disclosure. So I don't really, I don't have a target for the S&P. I do think that the S&P is, you know, corporate profits, which for years have been mean reverting, have not been. And, you know, this has been a golden age for the corporation in terms of profitability and valuations. And, you know, that remains to be seen whether those profit margins will hold up longer term. They're at record levels.

So, you know, I don't know where the S&P can trade. That's a, that's my cop-out answer. I know that some of the stuff we're in just trades at such extreme premiums to that, that if the market goes nowhere, I think we're going to do just fine on our short portfolio. What's most overvalued to you? Right now, I think that if you can find any companies, and there are a lot of them, that are earning low to mid-single-digit's return on capital, things like the real estate industry, for example, or a number of consumer companies, a number of companies in the ESG space, like solar.

The union economics are just crappy, but there's a narrative and where there's leverage. And there are lots and lots of these names out there. Those are going to, I think, be problematic going forward if rates drift higher. is again, people just are used to financing things at two and three percent. And those days may be over. Man, I have a million questions. You know, certainly, obviously, you know, we're not going to get the Jim Chano's S&P end of 2022, S&P forecast. But I am curious more broadly, because everyone's like, is this the bottom, is this the bottom?

You've seen these cycles. Obviously, there was the dot-com era. You've seen lots of other crashes. How should people think about what it looks like, not from a numeric, perspective per se, but what it looks like when the paint ends or what other things people might look forward and say, okay, this is now, this is what bottoms kind of look like. What I've been kind of surprised at, and this sort of again, to use the, it's never exactly the same, but to use the 2000 analog, I've been kind of surprised since November just how much

retail investors continue to want to speculate. Yeah. And that, that to me has been, One of the things that's kept me, you know, as exposed on the short side, you know, in our hedge fund and short fund as I have been. I mean, you know, Kathy Wood was getting, you know, inflows for most of the first quarter. In some cases, record inflows. And we see it in the meme stocks that people were still speculating every time the market, you know, started to stop going down. The meme stocks would jump. And every time the market stops going down, my shorts typically go up 30 to 40, 50% in two weeks.

And that's exactly what they did in 2000 and 2001 and 2002. And people just are still, I still want to believe that this is the bottom, that I'm, you know, I'm going to make my stand here. And I don't know. But I do know that the willingness, particularly of the people who came late to the party, the retail investor buying individual stocks are options, to still speculate. is still there. And it's somewhat shocking to me. Now, this latest swoon and the crypto selloff we're seeing may dampen some of that. We'll have to see. But that's been one of the surprises to me

is just how much people are willing to keep come in and when the market sort of stops going down by the most speculative stocks for a bounce. So we've been talking obviously a lot about the sort of the retail angle, because that really does sort of dominate the story maybe since the end of 2018 or middle of 2019 when the free trade started. Yeah. But the other big, one of the big stories of the last 12 years or maybe much longer, and I know that you've been critical of it is the opposite, the PE industry institutional and like the degree to which that has been this sort of like one-way train up.

I'm pretty sure you're skeptical of some of the marks they've had over the years. Like, is this going to be the end for some of these highly, especially of interest rates, go to where you're talking about them. Is this going to be the end for some of these more leveraged models? So a couple of things about the private equity industry. I suspect they're about to have the same reality check that hedge funds had after the global financial crisis. So as we talked about a little earlier, you know, hedge funds made their chops in the first,

you know, first seven or eight years of this century, right? They were short the dot-com garbage. they were long value, and both of those trades paid off from 2000 to 07 in a big way. And hedge funds began to attract large amounts of assets. And it completely fell apart in the GFC. Most equity hedge funds, we're talking about equity hedge funds here. Most equity hedge funds were net long and buying value all the way down and got killed. And hedge funds have had a rough go of it ever since, really, quite frankly.

Think about private equity. Private equity has had two major developments at their wind at their back for the last, you know, 40 years, but particularly for the last, certainly 12 years. And that is massively declining interest rates and rising equity values. And so if you are a leverage buyer of equities, that has been a massive tailwind. And what is shocking to me, and I allocate capital, I sit on some investment committees, so I see the private equity numbers. I hear the pitches. What is shocking to me is that if you were buying a portfolio of stocks leverage two or three to one, that you would expect to be doing a hell of a lot better than the S&P 500 over the past 12 years of the Russell, you know, even net of fees. And the fact of the matter is that's not really been the case. And I think that's going to be one of the biggest problems for private equity.

is the fact that the returns, net of fees and adjusted for leverage have gotten a lot more pedestrian in the last handful of years. And if we're going to revalue interest rates structurally higher where you're not going to get easy exits and the IPO market closes down, then private equity is going to have some heavy weather of it. And it has been the asset of choice for institutional investors. There's no doubt about that. And I think that, you know, that, that alone tells me that if you're big in private equity, you ought to be taking a look at your allocations and understanding you own leverage equity. And just because they don't market, you know, promptly, does it mean you're not taking the risks?

And that's my concern about private equity. So just to broaden that point out a little bit, you know, we are at the point now where some people are drawing parallels to 2008. and the financial crisis. And or, you know, they say, oh, we're going to get there. But the difference that you often hear stated between 2008 and now is the reduction in leverage in the financial system. And I'm curious what you think about the degree of leverage that may or may not be out there because, you know, especially with something like crypto, it feels like it's such a new asset class and it's quite hard to track. It feels like there could be linkages there that we just don't really have a good sense of at the moment. Yeah, I mean, we clearly, you know, the warning signs were

everywhere back in 06 and 07, because you could see it on the balance sheets, right, of the banks and the brokers. They were just getting more and more levered, and they were getting more and levered to so-called level two and level three assets, which were harder and harder to value. And in this go-round, you know, I think that the generals basically always fight the last war, right, and we regulated the banking system pretty tightly after the GFC. And so I don't think there's systemic banking risk out there in terms of the need for government intervention and what we saw in 08 and 09. It's much more diffuse and it's much more localized and things like crypto.

And as you say, is there's hidden leverage in that system. My guess is there is, but we'll find out probably shortly. And then other mechanisms, we haven't talked about FinTech, but sort of the shadow banking world of FinTech, which, you know, I've been joking now for a while, it's just simply subprime lending, you know, done on an app. You know, we'll find bodies floating to the surface probably there before all of a sudden done as well. I don't think the systemic issues, though, are the same. And every, every bull market has its own flavor. And this one was not as debt-driven, you know, as it would relate to, I think, risk. to the banking system. Now, there's plenty of leverage out there in corporate leverage. And again,

I think the risk might not be credit risk. It might be rate risk. That's, you know, a whole different, that was the 70s. And that's a whole different kettle of fish than sort of these deflationary credit shocks we had in the past 20 years. So again, we'll have to see. Now, if you want to talk about systemic problems. And, you know, there's lots of them elsewhere around the globe. And then on top of it, I think you've got geopolitical issues that are probably, you know, really, really different from the last 10 to 20 years, you know, the rise of China. And, you know, for God's sakes, we have a land war going on in Europe right now. You mentioned FinTech for a second. And you also mentioned it earlier in the chat. Can you tell what is it about this particular industry and the way

it's structured? I don't even know what fintech is, to be honest. Sometimes, like, I don't know if it's lending or trade, whatever it did, but what is it about fintech that caused you to focus some, or that you see such egregious valuations and business models? FinTech is a label used to get higher valuations. I know. I know Tracy has strong opinions on fintech. I need to interview her sometime all about it. And it, and it boil, and it furthermore, since the advent of the internet, it really has boiled down to, we have a way of figuring out what people who generally don't pay back their loans will pay back their loans. So we have algorithms and we have big data and we have all these things that these stodgy

bank and credit rating agencies and consumer credit companies haven't figured out. And we're going to get people to pay us back who are paying us, we're lending lots of money to it big, big rates and fees. and every down cycle, you know, since 98, has seen those companies blow up because it turns out they didn't have a better mousetrap. They just had the credit cycle in their back. And the algorithms didn't work, you know, when things got tough. And I think this is going to be no different. I mean, I just, you know, I just see the narratives by companies that claim they've figured this out again.

And the reality is, is that after 12 years of easy credit and consumers getting flush with government payments and all kinds of things, you know, everybody looks like a great credit. It's not going to be till times get tough that you're going to see, you know, where the risks in your portfolio are. And this was just another way for Silicon Valley to kind of tell another narrative. But this one's been around for a while. The first fintech companies came out in 98, 99. I have a process question based on that answer, but you talked about the idea of the credit cycle at a company's back.

When you're making your investments, and in particular when you're assuming short positions, how do you balance the macro environment and your expectations for the broader economy versus company-specific insights that you might have? Because, again, we kind of hinted at this at the beginning in the intro, but it's, I don't want to say it's easy, but you can find a company and say like, wow, this company has problems. There's a flaw in the business model. But if everything's moving in its favor, if there aren't very many defaults at that particular moment in time, it can kind of go along just fine for quite a while. So how do you balance those two things? Yeah.

So, and can and does. And so, look, what we're trying to find, what we're trying to find particularly, apropos Joe's comments at the beginning of our conversation is the business, does the business look problematic when everything should be going its way? Facts the odds in the skeptics favor, right? So if you're a food delivery company and you're not making money when people are throwing money at you and everybody's at home, you know, maybe you have an issue. And maybe the model just doesn't work.

And so, again, we're looking for businesses that with really low return on invested capital. It's a big, big thing we focus on. You know, for every dollar you give them to invest in the business, what do they return? And, you know, for most of corporate America, that number is in double digits. It's somewhere, you know, in the mid-teens to low teens. And yet there's just lots of companies out there that people have thrown money out that are earning four, five, six percent on their capital. And if you're only earning four or five or six percent of capital at the top of the business cycle with rates at two or three percent, you know, you're going to be in trouble.

So we try to look at the macro and understand that there will be cycles and to try to find companies that are either unprofitable or barely profitable, you know, when things are good. Because certainly things, when things aren't good, they're going to make heavy weather of it. I should make one other point, Tracy. And that's the other thing that has really struck us in this cycle, which is sort of addresses this question of yours, is the amazing use of pro forma metrics by corporate America. And, you know, it's amazing how many companies will report numbers and the media will dutifully say, you know, Salesforce.com, you know, beat expectations and, you know, made so much money. And then you look at the actual financial statements, you see they lost money. And, you know, this is getting worse and worse. And I think, you know, as it relates to the course I teach on fraud, you know, I've been telling my students for the last couple years that a lot of the disingenuousness in corporate America is happening right in front of you through the aggressive use of self-defined metrics.

And the most egregious of which, of course, is adding back share-based compensation, which Silicon Valley is just. you know, lavish in using. And as long as we just pay our people in stock, that doesn't count. And I think that virtuous circle is going to turn into a vicious cycle on the way back down. It already has for some companies. Right. Because presumably, if the assumption no longer exists that stocks only go up, then people might actually want more cash. Exactly. And then you have to run it through your P&L. Or the equity, you're just going to have just a lot more dilution.

You're going to have to just issue more and more shares for a given dollar value. And so, you know, in any case, I think that that metric, and for example, the gig economy companies, they were just masters at this. Uber, Lyft, DoorDash, they'll tell you adjusted, they're going to all be adjusted, even though positive at some point in the future. And then you look at the numbers and they're losing 100%. of millions of dollars I've recorded. Eating well shouldn't be complicated,

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Beanie babies? Is that all there is? No, that's NFTs. Okay. Sorry. But look, you know, the thing about alternative monetary systems is there's a long history of them. And they tend to be adopted or embraced or recommended in good times, not bad times. And I think that's a really interesting, you know, aside that I tell my friends who are kind of heavily invested in the concept of crypto.

And the first guy to think about this I teach in my fraud course was John Law, maybe the greatest financial criminal of all time. He wrote about this in 1705 and on this seminal work he did on the nature of fiat currencies. And he pointed out that the state should embrace fiat and he knew the risks. He knew the risks of debasement and inflation and all of these things, the reason why people wanted gold and silver and not paper. But he also made a couple of really interesting observations, and one of which was that in times of stress, and I'm forgetting his actual term from 1705, but that people actually will embrace government-based fiat because the government can adjudicate fraud and contracts. And then he talked about the fact that a banking system based on that could also offer protection. He didn't say deposit insurance, so he wasn't that far thinking yet. But it was the first sort of forerunners of that.

And the whole idea that when, you know, you are in a situation where nobody trusts anything, you actually want the state to back things. And you want the ability of the Federal Reserve to be a lender of last resort. And you want to have the fact that you know that if you have $250,000 in the bank, no matter what happens, you still have $250,000 in the bank. And I think that's a really important concept that we kind of forget every time everything's going to the moon. and we're all making lots of money, you know, speculating in things. And that's the really interesting thing about crypto to me is that a lot of the concepts

behind its adoption early on have proven to basically be not there or wanting. You know, it was going to be a replacement currency. Well, no, it's not. Well, it's going to be a diversifying asset. Well, no, it hasn't been. and we can check down the list and you know it better than I do. But I do think there was a seminal moment was the interview that you had with Sam Bankman-Free. And I said so at the time.

I mean, that to me was a bell loud and clear that one of the crypto giants is telling you, you know, flat out. Yeah. We were pretty shocked. Yeah. It is Ponzi-Nomics. And, you know, he said the reason. real quiet part out loud. And that's when you boil down a lot of these structures. That's what they are. And I've called it a predatory junkyard. And I stand by that. So I have a philosophical

question based on that. But, you know, there are a lot of hardcore crypto believers out there, especially of Bitcoin, the Bitcoin maximalists and those types. And they look at something like Bitcoin and say, oh, this is the future of the monetary system and everything is going to change because of this. And then someone like you looks at Bitcoin and presumably says, this is a Ponzi. And, you know, it's just money following money. And that's all there is to it. How is it that two different people can look at the same asset like a Bitcoin and come to wildly different conclusions about its worth and its value? So I should say that, you know, Bitcoin is the leading currency. sort of like the dollar of the crypto space.

And because of its limited, you know, issuance, whatever, I have no idea where it's going to trade. But what my problem was was all the ecosystem built around crypto that is clearly just rent-seeking. And that's been my criticism of the whole space is just all the various staking things, the year, quote-unquote yields, the ridiculously high fees they charge.

I've been publicly short Coinbase, not because I thought Bitcoin was going down, but because they're over-earning. And so that to me was really, was this vast ecosystem that sprung up overnight around it to basically extract fees from unsuspecting primarily retail investors. I'll give you a great example. So if you look at Coinbase's first quarter in 2022, retail trading volume was, huge compared to institutional, but they earned almost the revenues. They earned almost a billion in commission revenues from retail traders during the quarter, and they earned only less than 50 million from institutional investors. Turns out that on a dollar value, a trading volume,

retail is paying almost 60 times the rate of institutions. And so, you know, it gets to my point that this is borderline, you know, predatory behavior in the industry where the fees and everything else is just outrageous. Not to mention some of the claims about how you're yielding and what the economic engine is behind these yields. And that's my complaint with what's going on in crypto is all of the circus around it. I want to ask you, you mentioned Coinbase, but I got to ask you about another specific company that you've had opinions on over the years.

Of course, that's Tesla. I know you're assorted for a long time that I think you paired back your shorts as it went to the moon. And, you know, I still, obviously, it's come back. But it's in a way, you know, it's like the bellwether of the Kathy Wood portfolio. It's also probably like the ultimate meme stock. Does it, is it a sustainable company at this point? Like, A, do you have a position on it? But B, do you, what do you, like, what is it?

When you look at Tesla right now, what do you see? Well, I see a company, yes, they will, they will survive. They've made it past 2018. That was in question, as Musk, you know, admitted later. But no, they, they certainly at this point, you know, got past the tipping point. However, it's a big however, they are dramatically over-earning right now. And I think the risk to the stock is the fact that, and I do think, by the way, I think it is the Bellwether stock in the stock market.

I think it's sort of like Cisco was in 1999, where people were just kind of putting their hopes and dreams on, you know, any hardware having to do with the internet, Cisco was going to dominate it. And it's the same sort of thing now. So whether it's EVs or solar or what have you, you know, Tesla is seen as the one-stop shopping for that. And I think that accordingly, you know, Tesla still trades at almost 10 times revenues and 30 times gross profits. So it's trading, you know, like a SaaS company, but it is an auto company. It has gross margins of 30%. Now, the risk they have is that almost every other auto company in the world has gross

margins of 20%. And so Tesla, which is earning, you know, trading it is just a monster multiple, is also trading on a monster multiple of a profit stream that is going to get competed. And that is the risk of Tesla. becomes, you know, just an established EV company amongst a whole bunch of established EV companies. And I think that one of the things that people thought was that, you know, the other OEMs would never get their act together. And certainly for a while, they didn't. But now with the advent of Ford and, you know, the F-150 lightning and lots of other products that are both out and coming, you know, it's going to be the auto industry.

And make no mistake about it, Tesla is a car company. They're building car plants. They're capital intensive. There's one of the risks to Tesla that I think is underappreciated by the market. And that is this company turned the profitability corner when it opened the China plant. And we and others have a large suspicion that a disproportionate amount of the profits are coming out of Shanghai. And that, of course, raises all kinds of other risks to the multiple and whether or not they can actually get their hands on. that money. And I think that's not appreciated by the market as much as it should be. If you look at the

company's gross profit margins, it took off as soon as Shanghai, you know, started volume production. Do you have a position on Tesla now? Yeah, yeah. We're short. We have a, we have a push position. Yeah. I know you've been critical of regulators, and you mentioned earlier that regulators are sort backward looking and always fighting the last war. And I guess my question is, why is that? Because you know, you look at something like Tesla and Elon Musk and the circus around Twitter, you could easily make the case that the SEC should be doing something here. Certainly, if you look at crypto, you could certainly make the case they should do something here. And there's very little incentive for governments to actually let crypto, you know, just run wild. I mean,

especially since a lot of crypto proponents basically say we're trying to create an alternative monetary system to a government-dominated one. But what's going on? Like, why don't the regulators get more involved? So I've said a couple of things. I've said obviously that journalists and short-sellers, we're being very self-serving here, are real-time financial detectives because they're incentivized to look for things. Whereas regulators and law enforcement and legislators are financial archaeologists. They'll tell you, you know, with much clarity, five or ten years after the fact why you lost money and why this was fraudulent. And a lot of that has to do with the fact that much of that is political by its very nature. And I've also said that basically

the strongest defense attorney and the harshest prosecutor for any company is its stock price. and that when everything's going up, it's kind of hard to throw stones, particularly politically, to say, okay, well, maybe we should be taking a look at this. What do you want to do? Stifle innovation? I mean, that was what the securities regulators heard about crypto. And in fact, I mean, to me, the failure of global securities regulators to, in concert, you know, basically declare most crypto coins and schemes securities is a major. are failing and because they clearly are. And I think that that would have stopped a lot of the nonsense that has subsequently happened if these coins and whoever had to register a security's offerings. I think that's one one easy thing to point out to say, you know, gee, you guys drop the ball on this one. But as for everything else, it's not until investors start losing money

that they begin to get upset with people. Look at the meme stocks in January. of in January of 2021, you know, when Robin Hood, because of capital issues, you know, froze people from adding to their accounts, people were upset because they couldn't buy more. And there were hearings about that. Yeah. The stocks are now down dramatically. But, and they were blaming shortsellers, for example, and hedge funds who got run over. It was, it was like bizarre a world. And, and And yet, you know, I talked to a lot of congressional staffs at that time. And, you know, they were just hearing from their constituents. How outrageous this was.

And, you know, these things are politically motivated with a lag. Yeah, it's crazy in retrospect, all these different politicians about the outrage of not being able to add to your GameStop position in February 2821. You know, I want to go back to something. You're talking about rates resetting and or moving significantly higher. And I don't listen to many podcasts because I don't really have time. But one that I did listen to is one that you did years ago with Matt Klein when he was at the FT. And you talked a bit about the business of short selling and in particular how short sellers think about rates. And the fact that in a ZERP environment, it's kind of no fun or no great because you sell a share, you get cash and you park it somewhere.

But you don't get any yield on that cash, which I had never heard and no one really talks about that. So like, does the business of short selling get better in this higher rate environment? Because you can earn yield on the cash that you talk a little bit about the business of short selling in a different rate environment. Yeah. So a big part, so the golden age of short selling alpha was basically, you know, the 80s and the late 90s. And part of that was due to basically the fact that in addition to the fact that stocks, you know, basically fluctuated a lot was that, you know, on your short sale proceeds, you got 80%, you split with the prime broker, typically 80, 20. The cash received the interest on that segregated cash.

So when rates were six and five and six and seven percent, you were earning five or six percent on the cash. That was a big cushion. Now, obviously, you're obligated to pay any dividends from your short position, but a lot of shorts, you know, have very low yields or don't pay dividends. that was a nice, nice, you know, cushion to the short side. That all went away with ZERP, right? And there was another factor that prior to really the GFC, that there was kind of a floor on negative rebates at zero percent, that in effect, unless it was a really crazy risk garb situation or something,

that it was very rare that you actually had to pay to short something. You might earn a lower interest rate. You might earn 2% instead of 6%. on the cash, but you didn't have to pay negative 10 or 20. And with the advent of much more transparent market, algorithmic trading, where you have these monster books that are long and short or whatever, rebate rates, you know, often go negative and hard to borrow stocks. And that became a new reality. So those two factors definitely impacted your returns on the short side, both relatively and absolutely. Jim, I think that's a great place.

leave it. I mean, we could talk for hours and hours longer, but this was a real treat. It's kind of crazy. It took us so long to have you on, but it seems like perfect timing. So appreciate you coming on oddlaws. I'm so happy we finally, finally got to do it. Thank you. We got to do it again. No more waiting six years. All right. All right. Thanks, Jim. That was fun. Yeah, thank you. Thanks, great. Well, obviously, that was great. It's a real treat to talk to Jim. Hearing him talk about some of these other areas that are tech and how much he sees, like, this sort of what he views is like this egregious evaluation is pretty eye-opening. Yeah. And it sort of gets to the,

that Ponziomics point. Like, obviously, a stock isn't necessarily a Ponzi, you know, a company can have real cash flows and real potential profits. But it does feel like we have had this, I guess, this overall dynamic of just money flowing into things, almost. almost indiscriminately, it feels like. Well, you know, one thing, too, is listening to this, and it's sort of obvious, but I think it's worth driving home. The stakes are extremely high for whether this question of, will inflation essentially be transitory or will, like, or are we in a new sustained, higher inflation, higher rate

environment? Because if we really are like, the yields are going to continue to go chase it, then that's where you get into, you know, you're talking about utilities. Or you talk about like reits. Like, you know, these are sort of like industry. and sectors that aren't particularly sexy by any stretch, but they are very rate sensitive and there's a lot of room for multiples potentially to come down. So to hear them talk about rates or do you hear them talk about data centers or to hear them talk about utilities in this sort of

same breath as fintechs and cryptos and gig economy stocks, you could see like how high the stakes are for like, well, where do rates end up? What is like terminal? What does the terminal look like? Right. Like your entire reputation as an investor is going to come down to whether you get the inflation call right. Because that's going to change everything in markets. Right. I mean, arguably at our head, but I mean, still, yeah, like there's huge swathes of the market that could be very highly affected by what goes on from here still. Yeah. Anyway, tons to digest there. We got to do, can we do an episode where I interview you about fintech? I mean, I do have thoughts. And it did come up recently in our stable coin. episode, the parallels with P to P.

But I do feel like, to some extent, like the peer-to-peer bubble or direct lending bubble was like a very nice microcosm of a lot of the trends that we're seeing now. But anyway, let's leave it there. Let's leave it there. Okay. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway.

And I'm Jill Wisenthal. You can follow me on Twitter at the stalwart. Follow our guest, Jim Chano is on Twitter. He's at Wall Street Cynic. Follow our producer, Carmen Rodriguez, at Carmen Armin. Follow the Bloomberg head of podcast, Francesca Levy, at Francesca Today. And check out all of our podcasts at Bloomberg under the handle at podcasts. Thanks for listening.