If you are active on the London stock market, you will likely have been following the monumental blow-up at Burford Capital (LSE:BUR) that has been subject to much speculation over the past week.
Last Tuesday, renowned hedge fund Muddy Waters, ran by Carson Block, announced that it was short a company that appeared to have a London listing- given the mention of 08:00. It is worth noting that, at this point, Muddy Water had not actually spoken named the company to which it was referring. Regardless, Burford Capital ended the day down by nearly 25pc.
The next morning, Burford issued a response to the share price movement. Which was odd, because, although nobody had accused anybody of anything, it still had this to say:
Was it strongly suspicious? On what evidence? Who was it going to take legal action against – Twitter speculators and bulletin board rumourmongers? This smacked of 1) insecurity, and 2) desperation. The very fact that it was threatening an enemy that – to that point – did not exist was a big red flag to investors. A few hours later (Muddy Waters was late as it was checking with counsel), it was revealed that it was indeed Burford who was the short target.
It is worth being aware of Muddy Waters – in 2016 it claimed that St. Jude Medical’s implantable medical devices and pacemakers were susceptible to hacking. Naturally, the fund was sued, and only the US Food & Drug Administration sided with Muddy Waters. These guys are not amateurs. They have done their homework. So, when they lay out a huge dossier of evidence against a stock, knowing full well that being sued is a common occupational hazard, it is downright silly to assume they are telling porkies to make a quick buck. But a quick buck they did make. Reports have suggested that Muddy Waters has now closed some of its position, banking a healthy profit from its dramatic antics.
Is shorting ethical?
There are two sides here: one that believes Muddy Waters has deliberately orchestrated its short attack to maximum effect to enlarge its own profit, which is market manipulation. The other side (the side I am on) believes that all Muddy Waters did was bring balance to an inefficient price. With Burford’s shares de-rating to not far off book value, perhaps that is the price at which a litigation firm should be valued.
It would be interesting to ask those who believe Muddy Waters has done wrong what they think of paid stock promotion. Companies can (and do) pay people to promote their shares – sometimes without even owning the shares themselves. Is that not more disingenuous than what Muddy Waters did? It took a position, then released its research on why it had taken that position. It is no different from you or I accumulating a position in a small-cap, and not revealing the company and why we have been buying until we have our fill.
Why didn’t investors do their research?
The harsh reality is that Muddy Waters had no inside information. Absolutely none. It had not done any research that nobody else could have done. Investors just presumably could not be bothered or were momentum strategists – an approach that will have served them very well in the last few years. Had the stock broken out, I might well have been long, but as I warned on the Investors Chronicle podcast last week, the chart had been giving plenty of warning signs, and I said the short trade was the breakdown on 1420. It broke down through 1420, and a few days later Muddy Waters came out with its note.
The chart often tells us what is happening
By looking at Burford Capital’s chart, we can see that the 200 EMA and 200 MA were breached and the shares had struggled to set a new high since September last year. It had created a point of support that would have suggested trouble if breached.
Now, nobody could have foreseen the Muddy Waters attack, but one thing is certain- the market clearly knew something was up. Very often, we will see a stock trend downwards before a profit warning, or a share placing, and the reason becomes apparent after the move. That is exactly what happened here.
Muddy Waters were not the first
It is worth pointing out that Canaccord Genuity initiated coverage on Burford with a sell rating on 7 February 2019, when the share price was 1822p. The broker followed this up with a 50-page in-depth piece on 30 April in which it outlined the sell case in detail. Before the Muddy Waters report on Tuesday, the shares closed at 1381p on Monday 5 August – down 24pc since initiation of coverage. The report does highlight several of the concerns outlined in the Muddy Waters, but nobody listened.
The saga is not over yet
With rumours of Gotham entering the fray, it is unlikely we have seen the end of volatility in Burford’s stock price. If you want to trade this, adjust your position size for volatility and manage your risk.
Evidence of market manipulation
Personally, I don’t buy this – mainly because it’s standard practice and a big “so what?” for anyone who trades SETS.
In the process of spoofing, or placing and cancelling a high volume of orders, it can be argued that the spoofer is trying to get filled by lowering their price on the offer and therefore making the shares more attractive to buy. That is, in essence, the very definition of a market: buyers and sellers working their way towards an agreed price.
Spoofing also does not magically change someone’s bid. So, if the spoofer lowers their price into someone’s bid – guess what? They’re filled!
Layering is also common. If this were market manipulation, then the entire market would be behind bars. As they are not, I can only assume it isn’t. If someone wants to take the risk of placing more shares onto the bid or ask to make it look more attractive, then they’re taking the risk of someone coming along and filling them. And once they are filled, there is not anything they can do.
A very interesting RNS, but nothing nobody didn’t really know already.
You can learn more from Michael by downloading his fantastic free book How to Make Six Figures in Stocks. This can be downloaded from his website – https://www.shiftingshares.com/