HYBRID VIGOR: VOL 3 ISSUE 11 "Dislocation Nation"

In a world where a reality-TV star of hyped but dubious business acumen and even more dubious financial standing has all but been anointed a top presidential candidate, it shouldn’t be surprising that last week’s markets were roiled by the continuing downfall of a company whose success became an article of faith. Trust us, Valeant said, and investors who should have known better did. The unwind of these things is never pretty, and last week, the collateral damage was frightening indeed.

We may be seeing the kinder, gentler side this morning. Some names that got absolutely pulverized (from pulvus, Latin for dust, which was where some of these health-care names got left in Valeant’s aftermath) appear to be getting injected with sanity and life. If so, we should see a continuing rally in health-care and biotech, two areas that have struggled to participate in the rip-roaring-rally that has undone the bear market of 2016.

Regarding Valeant: an investor we’ve long admired as a teacher and friend often uses short interest in a contrary non-contrary way. While conventional wisdom says that short interest creates buying power, potentially in a squeeze, the contrary non-contrary view dictates that short sellers should be mimicked and followed. Shorting is, after all, the most dangerous game in investing, and they wouldn’t be doing it if they didn’t know. (This presumes, of course, that the analyst has carved aside any short-selling related to some form of arbitrage or quasi-arbitrage).

Where it gets tricky is when one takes the absence of short selling to be a powerful bullish signal. Here we disagree. There can be many reasons why a stock is not heavily shorted, even if the stock’s merits are iffy at best. One big one is when a high-profile investor is loudly long. That investor may be right or wrong, but going against that investor, especially for investors in fiduciary roles, is another dangerous game. I suspect that Valeant was not heavily shorted a year ago because going against Bill Ackman didn’t seem like a very good career move.

The crumble has surely tainted some names that don’t deserve the taint—both pharmaceuticals that like to grow by acquisition and some of the prospective candidates. Perhaps today’s action is the start of dislocation nation coming back to more reasonable, healthy underpinnings. Morning in America, you might say.

(This is the cover letter for the subscription-based weekly Hillside's Hybrid Vigor newsletter. For a complete copy, please contact John Anderson at + 1 (646) 712-9289 x 107).