REUTERS/Rick Wilking
The market needs to embrace short sellers if it wants to free itself of fraud, Carson Block told Bloomberg TV.
But being a contrarian right now is a challenge, with short sellers increasingly out of place in the latest bull rally, the Muddy Waters founder said. Where sellers profit by betting against problematic firms, most investors today are chasing narratives and speculation, he said.
"There are more companies playing more games. A lot of them are in the gray zone; you don't know whether it's over the line or not," Block said. "So they're not gonna get prosecuted in this environment."
He added: "The market needs short sellers more than ever, given the amount of games that are being played. But if the long side doesn't care, then, you know, this can continue until it doesn't."
Block isn't alone in making this point.
Last month, legendary investor Jim Chanos told Bloomberg that the market was riding through "the golden age of fraud," as today's record-breaking market run is pumping up valuations even for companies that don't deserve it.
Chanos, who garnered fame on Wall Street for forecasting Enron's downfall, closed his hedge funds last year. He cited a changed marketplace, where passive investing has placed pressure on short sellers.
In February, David Einhorn also shared frustration with today's market behavior. Investors are trading on a firm's fundamental merits less and less, he said. Instead, passive investors have "completely annihilated" the value industry.
Although Einhorn's Greenlight Capital was up 22.1% last year, he cited significant losses on four short positions in a letter to clients.
Faced with this environment, JPMorgan said that short bets on major US indexes fell to record lows in late June. That's because short positions are expensive to hold when the market is constantly climbing, it said.
But according to Block, not only are short sellers hampered by the speculative frenzy, these traders are facing pushback from regulators and "populist" investors.
He argued that short sellers who seek out fraudulent or failing firms have been helpful to agencies such as the US Securities and Exchange Commision.
Meanwhile, some companies have taken to trying to turn investors against short sellers, Block added. Tesla's CEO Elon Musk has often lamented short positions on its stock, pushing Tesla higher, he noted.
"It's easy to demonize short sellers, as part of the populist messaging, and somehow call us suits," Block said.
Trump Media and Technology Group offers a more recent example. The company attracted a number of short positions after going public in March, causing it to issue warnings to its investors on how to combat short sellers.
After posting the advice, the stock jumped 12%.
