Twilight Of The Shorts

Short-sellers, who bet on stocks declining, are used to getting less respect than Rodney Dangerfield. But short-sellers don't mind being despised--it's losing money they really hate. And for three straight years, many shorts have seen the red ink flow like Niagara. With the stock market hitting all-time highs and small stocks in particular on the march, short-sellers have seen their portfolios decline by an average of 4% through Sept. 30, vs. a 5.3% gain in the Standard & Poor's 500-stock index, with some shorts realizing declines of as much as 42%.

It's not just a temporary setback but rather a sign of extended malaise for an institution--the short-only investment fund--that saw its heyday in the 1980s. And the shorts have acknowledged their woes themselves, with many of them now buying stocks as well as selling them short. What went wrong?

For one thing, a number of short-sellers bet heavily on banks and real estate plays that went due north beginning in 1991. And right now, the upward price momentum of a long list of heavily shorted stocks, most notably Snapple Beverage, Lone Star Steakhouse, Starbucks, and such gambling plays as Casino Magic, is surprisingly strong. "Since the gulf war, the winning strategy has been momentum investing"--a gamble on further price increases, observes Michael Murphy, editor of the Overpriced Stock Service newsletter, which recommends short positions. Moreover, the shorts largely ignored the No. 1 investment theme of the 1990s--low interest rates as the prime mover behind stock prices.

FLAWED AND FRAUD. The bleak outlook for the shorts is a far cry from the 1980s, when short-selling came into its own as an investment technique. In theory, at least, shorts can make plenty of money even in a bull market. They target weak or even fraudulent companies, often after backbreaking research. From 1985 through 1990, shorts enjoyed gains of 25% a year, says Harry Strunk, a Palm Beach (Fla.) investment consultant who tracks short-sellers.

Many shorts have reacted to the bleakness of the bull market by resorting to the old credo "If you can't beat 'em, join 'em." The once-mighty Feshbach brothers of Menlo Park, Calif., took devastating hits in the past three years, driving the $1 billion fund they had under management to just $250 million by last summer. Sources in the short biz say the Feshbachs holdings now total a mere $100 million. Most of that is in a "hedge fund" private partnership that goes both long and short.

Other shorts have followed suit. Tom and Joe Barton dissolved their partnership with the Feshbachs in July and are now running Dallas-based White Rock Capital, also a hedge fund.

More and more fund managers who still sell short admit that they are "boxing," or playing the same stocks both long and short, to lock in profits and tax positions. And in hedged portfolios, Strunk says players are rarely more than 30%-40% invested in short positions. Thus, even though in mid-October the NASDAQ hit a record level in uncovered short positions, topping 620 million shares, Murphy says that's misleading. Much short-selling now is part of boxing and other hedging strategies and not a straightforward wager that the stocks will drop. Shorts nowadays are keeping a low profile, with Murphy among the few diehards still willing to list the stocks he loves to hate. Among them are Blockbuster Video, CML Group, Home Depot, Zenith Electronics, Autozone, and Symbol Technologies.

Many shorts are waiting on the sidelines when it comes to gravity-defiers such as Snapple and Lone Star, believing they're unlikely to move until they miss quarterly earnings numbers in a big way. Says Strunk: "There's a lot of interest in the casinos and the restaurant sectors, but shorts are waiting to pull the trigger until they see the whites of [the companies'] eyes."

KEEPING WELL HEDGED. One sometime short-seller who is now only 25% short is Clifford W. Henry, a New York-based investment manager. Henry runs about $50 million, including the $20 million Worthington Growth hedge fund, and he's up 20% for the year--mainly by snapping up good-quality growth stocks, he says. But he is shorting the computer companies, particularly Dell Computer Corp. and Apple Computer Inc., on the theory that they are ripe for declines caused by "structural business problems." He also believes the big-name casinos and restaurants are way overvalued.

The problem, alas, is that such sentiments are a bit too widespread. If one wants to sell short nowadays, Henry says ruefully, "you better know something somebody else doesn't." That's the short-sellers' stock-in-trade--fundamental research. And it ought to pay off for the shorts. One of these days.