Fresh on the heels of the biggest-ever two-week drop in onshore dollar-yuan, noted China bear Kyle Bass gave an interview where he addressed one of the most exasperating aspects of the short-selling business, and an issue that he is no doubt grappling with at this very moment: What to do when confidence in your investing thesis is undermined by uncooperative markets.
It’s been about three years since Bass first announced a massive bet against the Chinese yuan, a position that he has been forced to justify to his increasingly nervous investors, as the Chinese currency’s more than 6% surge since May – and its nearly 8% climb against the dollar so far this year - has more than reversed the currency’s largest one-year decline since 1994.
To be sure, he’s still willing to explain how ballooning assets in shady Chinese wealth management products, which have swollen to more than $40 trillion in aggregate, are destined to collapse in a cascade of bad debt, taking the country’s banking system down in the process.
He discussed his views on China – while also answering a few questions about events in his life that helped shape his investing outlook during an interview on “Adventures in Finance.”
After being asked about events in his life that inspired him, Bass shared a story about his upbringing in working class Texas, where he said he started working at the age of 13 and eventually paid his own way through school.
His family didn’t have money for little extras like eating out. This inspired Bass to be very diligent about saving.
“We never had enough capital to do the things other people were doing like go out to dinner a couple of nights a week…I’m not saying material success or anything but enough to live the life you want to live.
I started working when I was young and I kept working nonstop.
One day I was literally trying to scrape change together to eat and I said this will never happen to me another day in my life. That was a moment where I felt like I had gotten myself into a situation where I was spending more than I could earn and that was partly because I was pushing through an education and that inspired me.
Therefore, I always said that from the day I graduated college, I would save 50 cents of every dollar I ever earned. My parents we had a great family but they had their shortcomings and those shortcomings really drove me to save.”
Bass said he was lucky to be exposed to “some of the world’s best short sellers” early in his career, adding that the first stock he ever shorted went straight to zero…an experience that he ironically described as one of the worst things to happen to him.
“My second answer to your question is when I got into investing…I was covering event-driven accounts on the sell side for special situations and I was working with some of the world’s best short sellers and early on, one of the very first positions I ever took was I put a short position on a company – remember when East and West Germany came together and a lot of the East German companies were being subsidized, and yet they moved their way into the western capital markets and they went public and there was this shipping company…and if you looked through the numbers the executives were taking the revenue and subsidies and buying yachts and planes and cars…basically embezzling.
“The worst thing that happened to me was the first company I ever shorted it went from $100 to $80 to $60 to $40 to $20 - it just fell apart, which by the way, is the worst thing that can happen when you’re young and you’ve done a lot of work and you say to yourself ‘this is just easy.’”
I was wanting to conquer the world and conquer Wall Street and it was this beautiful complex jungle that you could navigate through.”
Brimming with confidence from his first big payday, Bass found another company that he believed was certain to fail…even confronting an executive who had abruptly left about possible malfeasance and illegality.
But unfortunately for Bass, this time, markets were less cooperative, and he lost everything.
“So, then the next position I took was we had worked with a bunch of accountants and combed through many balance sheets and income statements that we could and we found this company…Their income statement didn’t add up and their chief operating officer had just resigned for personal reasons and I made it my mission to track him down. I finally tacked him down and I said I just want to ask you a few questions about your income statement and why you resigned…he said he left that company because the CEO asked him to zero out some cost of goods sold line items so it could stay within its debt covenants and I wasn’t willing to break that ethical and legal barrier. And I said 'oh my goodness we’ve got them.'
I said have you spoken with the authorities. He said he hadn’t yet. And I said he needed to call the SEC right away.
We live in a world of imperfect information, but for those people who want to dig and do a lot of the work and get to a place where you end up getting as much information as you can and acting on it.”
Thinking it the firm’s stock was headed for an imminent collapse, Bass put all his money – hundreds of thousands of dollars – into a short position. But then the unexpected happened: an influential letter writer dubbed the stock a buy, and it soared. As Bass recalls, he got margin called “all the way up,” leaving him bankrupt.
“If you remember, during the tech craze there were all these momentum buyers…we had fully positioned ourselves and a letter writer named Carlton Lutz who wrote the technology markets letter of the day dubbed the company the son of Intel and the stock went promptly from about $16 a share to $40. I got margin called out all the way up until I was completely wiped out.
I was apoplectic I thought the world was going mad. Some of my well-heeled clients actually shorted more and the I remember that like it was yesterday and that was the greatest thing that ever happened to me, losing all of my money on something where I knew I was right.
From an investing perspective getting completely wiped out when it was so near and dear to me and thinking that it was the end of the world and that I was an abject failure and that the investing thing wasn’t for me…and looking back at it, it couldn’t have happened at a better time in my life. You want that to happen as early in your career as you can. You want it to be devastating…to teach you to bring humility to investing. You should never set yourself up for the knockout punch. You should never put 100% of your assets in anything."
In another example of how difficult it can be to correctly time a short play, Bass recounted the story of Avanti, a software company whose executives eventually went to prison for IP theft. From the beginning of the process to the end, it took seven years for the stock to drop.
“There was a company called Avanti that was designed by a couple of Cadence Design employees. The CEO was violently competitive so he wanted to launch a company to compete with them. So, what did they do? They stole the company’s software downloaded it onto their hard drives and left.
They put typos in the code so if anyone stole the code, it would be obvious…authorities had them cold. But it took the stock seven years to get obliterated. Those are big lessons because some of those lessons are hard to learn.”
Which finally brings us to China. Bass says he’s spent the last three years intently studying China’s credit system. But even though he’s convinced it’s one of the largest bubbles in financial history, calling the timing of the collapse has proven incredibly difficult.
“I’ve dedicated the last three years of my life to understanding China’s credit system. I would say we understand it as well as anyone in the world does. And it’s the biggest bubble we have ever seen in the history of financial markets. $40 trillion of assets in a system with $2 trillion in equity."
We wrote our magnum opus on this in 2016 and here we are in 2017 and it hasn’t happened.”
Aside from China's credit bubble, the simmering conflict in North Korea and tensions between the US and China related to the latter's insistence on building in the Spratly Islands also threaten China's economy, as well as global risk assets.
“We’re now in a bubble of epic proportions for Chinese credit...everything seems to be bubbling to the top and reaching a boiling point almost concurrently."
To be sure, there are a lot of powerful interests around the world that would suffer if China’s economy collapsed. But despite this, because he believes in the position, Bass is going to stay on his side of the trade – even as other longtime China bears like Mark Hart announced this week that he was abandoning a seven-year long bet on a massive yuan devaluation.
“People so want for everything to be okay. Nobody in their right mind wants us to be right because if I’m right were going to see a global growth slowdown you think about the concentric circles of how it affects each participant. The economy may really slow down and we might have additional problems…so I’m going to keep investing the way I am and hope it all works out.”
You can listen to the rest of the interview below: