The Next Black Swan? | Carson Block

**Carson Block** (0:00)
There is one potential black swan out there that I see that I don't think it's a near term risk. It's probably not a medium term risk. I do think that among insurers, there are a lot of problems. I think there's a systemic problem among insurers.

**Adam Taggart** (0:24)
Welcome to Thoughtful Money. I'm its founder and your host, Adam Taggart. Stocks entered the year trading at or near all-time record-high valuation extremes. So when stocks look richly valued like this, short-term sellers take notice. Is it time to start shorting the market here? To find out, today we've got the good fortune of welcoming back to the program one of the best-known short sellers in the business, Carson Block, founder of Muddy Waters Research. Carson, thanks so much for joining us today.

**Carson Block** (0:54)
Yeah, thanks for having me, Adam.

**Adam Taggart** (0:55)
Hey, it's such a pleasure to have you back, Carson. I really enjoyed our first conversation and the audience. I've been getting a lot of requests, say, when's Carson coming back on? Thank you for making the time here. Happy New Year, by the way. We're here still at the roughly start of the year. My question there in the intro about short-selling, obviously, Carson, you're one of the best in the business. Valuations when we talked last were pretty stretched. They seem to be, in many cases, even more stretched right now. But looking at some of your recent writings and work and interviews, it sounds, and correct me if I'm wrong on this, but it sounds like you think the current cycle still might have some juice left to run. I don't get the sense that you're saying it's time to go short. Is that correct?

**Carson Block** (1:44)
Yeah. So I guess it might be fair to characterize me as somewhat of an apostate in the short-selling world. But the comeback there is it's now a very, very small world when it comes to short-selling.
So there are a few things here. When you talk about valuations, prices have definitely decoupled from economic or fundamental value in a number of instances, especially for companies that are larger portions of popular indices. But the thing is, there are reasons why that has happened. And you have, and this is a rabbit hole, we've gone down a lot in our firm the past couple of years, where it really started with, well, okay, it started by getting beaten up on shorts for a number of years, right? And got into these conversations, especially a guy named Mike Green of Simplify Asset Management, who's been out there banging the drum for years about how passive investing is warping markets.

**Adam Taggart** (3:04)
Yeah, and start to interject, but just to let you know, this audience is pretty familiar with Mike and that passive bid framework.

**Carson Block** (3:11)
Great. So I know Mike, and we started conversing about this, maybe late 2019, early 2020 And what then ended up happening is we had somebody in our firm who ended up developing a systematic strategy, a momentum strategy, where we were going long constituents of the S&P 500 And we were measuring momentum in a way that's proprietary. But I was skeptical when he presented this to me, and he showed me the back test numbers in mid 2024
And I was skeptical that there was real edge there, and it just sounded like it was too simplistic. But we ended up putting this into practice in October of 24 And we've shot the lights out. The returns that we've made on this are just, they're almost obscene. And I really, as part of this, in my conversion to really, you know, I understood the arguments that Mike was making on an intellectual level, but I didn't really, my bones want to believe it fully because of my orientation as a short seller. But, you know, having taken advantage of this effect, I do feel this in my bones, but we've gone down the rabbit hole. And look, we really, we're not complimentary internally of the index providers, especially S&P, right? Like those S&P chases momentum when they add names to the index, especially the S&P 500 index, and the dynamics of market cap weighting create basically this recursive effect where, you know, momentum just feeds upon momentum. And then the smart companies, which, you know, a lot of these companies understand these mechanics, they play into it through share buybacks. And so, you know, that's why you have so many of these large companies where the prices are disconnected from what you would say the fundamental value should be. But should you short that? I mean, no. So long as you continue to get flows into these index funds, you know, that, that, I mean, that effect is going to continue. And the fundamentals matter less and less. Yes, fundamentals can matter on the margins if there's a bad quarter. But again, it could, that could shrink its, you know, given stocks percentage of the index. But if it's still on the winning side of that index, it'll continue to get flows. So it'll kind of just grow back up in proportion of the index. So, no, you shouldn't go in short Mag-7 because you think it's overvalued or what have you. What I think the future of traditional short selling is, now keep in mind, my firm, we're not traditional short sellers, we're activist short sellers. So for us, the idea has always been to use short selling as, you know, as an absolute return strategy. But generally, traditional short selling is not absolute return. It's there to smooth out volatility over the long term and also to allow you to finance your longs, the ones that you really like. Well, the case for traditional short selling as a volatility hedge or as a downside hedge, it's not really there anymore at present because when we have corrections, the corrections are so short in duration because the policy makers absolutely must prop up the markets. I mean, we are, you know, we are so as an economy, we are so heavily financialized that we cannot weather the pain of a real market correction or severe market correction. So policy makers have the motivation and now they have the intellectual property. They developed it post GFC and you really saw this put to use in COVID when that correction was so short in duration. So that's why that traditional view of, well, I want to allocate to short sellers as a hedge, you know, from when the market corrects, that's why that no longer holds water. But to finance your longs, yes, but the problem that, I mean, short selling traditionally has been this discipline where you go out there and you say, okay, I want to find the companies where the price is the most disconnected from the value. You know, another way of phrasing it is, I want to find the most screwed up companies. Now, when you get those massive disconnections, it's almost always because the company is actively doing something to cause that. They're hiding the ball, they're misleading investors, they're doing things to manipulate the perception of the company. So, in this environment, trying to identify those shorts to use them to finance your longs, basically, is a bad idea. So, if you look at any given index and you break it down into quintiles or deciles, right, that left most, in terms of the ones that underperform ultimately, you know, where they really crash, that's what everybody's searching for in terms of their mentality.