The first half of this year has produced a particularly frothy market, in which short sellers usually sink or swim. With pockets of overvaluation providing the opportunity for big returns and big losses, short sellers have entered into fewer campaigns for the period with greater effect.

What is the trend?

Activist short sellers have launched fewer campaigns this year than ever before, with only 63 initiated by June 21. The more careful approach has proved to be effective, with one-week campaign returns also topping records in the same period.

Since records began in 2013, average one-week short selling campaign returns have fluctuated, never moving past 6.9% as of June 21 each year. This year, average one-week campaign returns hit a whopping 7.9% in the same period, according to Activist Insight Shorts, which is also higher than any previous full year.

Average one-week campaign returns hit their lowest level year-to-date in 2016, when short sellers made an average 3.9% in the first week of a campaign. They have steadily risen since then, besides a slight dip below 6% in 2018.

Incidentally, in the same year that one-week returns hit their lowest point for the period between January 1 and June 21, the number of campaigns launched were at their highest, at 126.

Campaign returns data for this year excludes Citron Research’s campaign at GameStop, which saw huge volatility from retail traders taking investment cues from reddit forums, due to its outlier effect on the data.

Who is making it happen?

One of the biggest players of the year so far, and one of the most successful, has been Hindenburg Research. The short seller launched 29 campaigns by June 21, experiencing more highs than lows, with only one in five campaigns yielding a negative one-week return. Hindenburg’s biggest win, PureCycle Technologies, returned 55% in the first week after the short seller pointed to management’s poor track record and questioned the technology used by the plastics recycling company as well as its financial projections.

The largest one-week return came from Wolfpack Research’s attack on eHang, which yielded a 59% return in its first week. The short seller sent shares in the Nasdaq-listed Chinese autonomous flight company down after claiming it was “a stock promotion destined to crash and burn.”

Another player to have been busy in this period was Spruce Point Capital Management, having launched seven campaigns by June 21, 2021, with varying results. The short seller’s best performer was American Battery Metals, which yielded a 14.3% return in the first week after Spruce Point accused the clean energy company of being a “mere pretender riding the wave of misguided capital flows.”

Why is it happening?

Pockets of overvaluation have been cropping up within the investment market due to a combination of factors that also attract short sellers. The stimulation the U.S. government has been injecting into the economy has, along with low interest rates, encouraged more unsophisticated retail traders trade stocks, propping valuations higher than usual. The influx of cash into ESG stocks that can rise on the promise of green power, reduced carbon footprint, or clean technology, is also a factor in the rising market.

While overvalued stocks are attractive to short sellers, the presence of excited retail traders can make it hard for a dissenting opinion to gain traction. This has caused many short sellers to fall back and launch fewer campaigns during a time of such volatility. Some have even decided to duck out of the game completely. Veteran short seller Citron Research would usually contribute to a high number of campaigns but decided to throw in the towel at the start of the year, after it was blown out of the water by retail traders pushing up GameStop’s stock and squeezing the short sellers.

“There’s no question that there’s a new class of retail investor that’s been reinvigorated,” Spruce Point Founder Ben Axler told Activist Insight Shorts. “When presented with a sexy story and a broker pushing stories about a company that has billions of dollars of profit potential, it’s easy to get excited. But you can’t forget to do due diligence.”

Those that have persevered and provided such diligence have certainly been rewarded for their endurance and good timing, which White Diamond Head Analyst Adam Gefvert told Activist Insight Shorts is key for a campaign to have the desired effect.

“Short selling is great in this environment. Lots of stocks rally and then fade, so you can have a lot of small wins,” the activist explained. “You have to short when the stock sentiment turns negative, but then cover before it gets positive again.”

Short sellers have had to find the sweet spot between over-excited investment and the point when a company begins missing its projections and revealing its red flags. At this point, momentum stocks fade and the short seller is rewarded for its research.

White Diamond accomplished such a feat in April, when the short seller took a bet against Intrusion’s stock, claiming a new cybersecurity product that has been aggressively promoted and led to an 800% stock rise is nothing special. In the first week after the activist published its report, the campaign yielded a 45% return, the third highest in the period between January 1 and June 21, 2021.

How sustainable is the trend?

The elements pushing this trend seem to be showing no signs of slowing but it is expected that they have to at some point. Ben Axler told Activist Insight Shorts that share prices have a lot lower to go before finding fair valuations but expects the U.S. Federal Reserve System to acknowledge the current inflation and raise interest rates soon.

Alongside the retail exhaustion that Axler sees, the short seller also reckons that newly-public SPACs will reveal their true selves in a few more quarters when they fail to reach the expectations they set for themselves, which will boost short seller returns as investors lose faith in the projections made.

Until the market levels itself out again, short sellers can be expected to continue to bunker down and strike at the most opportune times, keeping campaign numbers low and returns levels high.

“It takes a while to shake the tree and get all the leaves down,” the activist noted. “Why it’s taking so much time I don’t know but we believe long-term prices should match up.”