Ocado’s surge shows what happens when a hated asset springs a surprise

published 18 May 2018

Yesterday, investors got an object lesson in the dangers of short-selling.

Online grocery logistics specialist Ocado an oft-derided tech company secured a deal with mammoth US grocery chain Kroger.

The share price rose by more than 40% on the day. At one point, it had spiked by 80%.

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It just goes to show what can happen when a widely-hated asset starts to get some love.

The highly risky business of shorting stocks

My colleague Dominic Frisby wrote a good piece the other day about why investors should be grateful for short-sellers, investors who make money by betting on a share price falling, rather than rising.

Shorts get a lot of abuse; investors who are "long" a stock tend to hate having its prospects called into question. And often, if a company has become a short-selling target, it's because there are obvious reasons for concern.

The company's business model may be a faith-based, "jam-tomorrow" one; the accounts may be complex and hard to understand. In other words, there's often an element of "if you build it, they will come" (to quote that Field of Dreams film) to these sorts of companies.

No one likes to have their faith questioned. And that's what short-sellers do.

However, being short is risky. If you are long, you can only lose 100% of your stake. That's not nice, but you know the worst-case scenario. If you are short, then your losses are technically unlimited. A share price can just keep going up.

And worse still, the turnaround can happen fast. When that occurs, everyone races to close their short positions in a panic, and the price spikes. And it looks as though that's exactly what happened with Ocado yesterday.

The tech company, once best-known for driving bags of Waitrose shopping around the place, has been one of the most persistently shorted stocks around for years. It was set up in 2000 by a group of former Goldman Sachs bankers. It went public in 2010.

Back then, it was hard to see how it could expand, given its ties to Waitrose. And it also seemed hard to see why anyone would use it, given that other supermarkets had their own online delivery services. One analyst famously said, years ago now: "Ocado starts with an o', ends with an o' and is worth zero."

And yet it turns out that, occasionally, if you build it, they really do come. (It also helps that a backdrop of incredibly low interest rates has created a very forgiving environment against which to run "jam tomorrow" companies, of course.)

Ocado has gradually struck more and more deals over the years, and now this one with Kroger appears to be a game changer. It certainly proves that the concept is not fundamentally flawed, if nothing else.

This asset is hated too but not quite as much as it was a few months ago

Anyway, why are we talking about this today? I'm certainly not going to suggest you take a punt on Ocado, or short the stock either I have a poor record on tech stocks and I haven't been paying much attention to Ocado in recent years, so you'd have to do your own research on that front.

However, I do think that it's an interesting illustration of just how rapidly things can move when an asset that lots of people hate sees its fortunes change or starts to convince investors that they're wrong.

That seems relevant in the context of the broader British market. We've been pointing out for a while that the monthly fund manager surveys from Bank of America Merrill Lynch (BoAML) have been flagging up just how despised UK assets are. Fund managers have been more "underweight" (ie avoiding British assets), than at any point in the relatively long history of the survey, for a while now.

Yet with the rapid turnaround in the oil price (as my colleague Matthew Partridge pointed out to me the other day, less than a year ago, Brent was still foundering around the $45 a barrel mark), the FTSE 100 has had an injection of enthusiasm. It closed at a record high yesterday.

There is a sense that the Bank of England might not be keen to raise interest rates soon, and a slip in sterling has also helped. But what might also be behind the shift is the sense that the negativity on the UK might be overdone.

The latest BoAML survey showed that global fund managers are starting to warm to UK assets again. In the last couple of months, allocations have jumped rapidly. And yet, there's still a long way to go until Britain is back in the good books or even remotely popular. "The UK remains the consensus short amongst UK fund managers," as the survey puts it.

You don't have to be particularly keen on the UK to make the case for investing. Indeed, MoneyWeek regular Jonathan Compton wrote rather an unimpressed piece on the UK economy in the magazine just a few weeks ago. (If you're not already a subscriber, sign up here).

However, as Jonathan also pointed out the negativity is in the price. You don't need a hated asset to become loved to profit from buying it. You just need it to become a little less hated.

That may be what's happening now.

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.