The Shorts Are Standing Tall Againby
Short-sellers are the pariahs of the investment world. Unpopular at times of market setbacks, when they tend to be the only ones making money, they suffer when the markets climb. In the bull market of the past three years, shorts have been miserable performers. But 1994 is shaping up as the best year for short-selling since 1990--and short-sellers are thumbing their noses at their enemies.
With interest-rate troubles pummeling stock prices, including the over-the-counter stocks that are the meat and potatoes of shorts, Wall Street's bears are charging. Through June 30, short-selling limited partnerships saw their portfolios climb 17%, according to preliminary figures compiled by Harry Strunk, a Palm Beach (Fla.) investment consultant who tracks the performance of short-sellers. "Every time you see the NASDAQ breaking down, you can bet that the shorts are doing well," says Strunk. And the NASDAQ has been awful this year, down 9.6% vs. 4.3% for the Standard & Poor's 500-stock index.
SNAKE EYES. It's more than just the declining market that has unleashed the shorts, who sell borrowed stock in the hope of replacing it at a lower price. There also has been a dramatic falloff in "short-busting"--buying into stocks because they have high short-interest ratios, driving up the price of stocks or otherwise forcing shorts to replace the shares they have borrowed. With the market decline taking the pizzazz out of short-busting, "the short squeezes have stopped entirely," asserts one major short-seller.
Not too surprisingly, the stock groups that have been kindest to the short-sellers have been crummy to everybody else. Casino stocks, such as President Riverboat Casinos Inc. and Grand Casinos Inc., for example, have been popular among the short-selling fraternity. Ditto for specialty-restaurant and computer-networking stocks, says Michael Murphy, a short-seller who expects the latter group to stage a recovery. Biotech stocks and pharmaceuticals also have been swell shorts, as have the short-sellers' friend--the overpriced, overhyped stock. "The way we've always made money on the short side is through stocks that are either frauds or their prospects are inflated," says Ben Kopin, who runs Lynx Partners in Chicago.
Short-selling's renewed popularity is evident in the short-interest statistics released annually by the stock exchanges and NASDAQ, the stock-trading system for the over-the-counter market. OTC short interest has more than doubled over the past three years, growing at a far greater pace than the increase in the number of OTC issues. But it's almost impossible to gauge how much of this comes from short-only investment managers. Short-seller Murphy, who edits the newsletter Overpriced Stock Service, notes that much of the short-selling that's reflected in these figures is by hedge funds, which often devote a portion of their assets to short-selling.
Short-sellers point to yet another nontraditional factor that has boosted short-selling: the growth of custom derivatives products. Some are designed by brokerage houses for customers desiring to bet on a decline in stock groups. Since it's not possible for an institution to buy a put option on, say, HMO stocks, the brokerages design one themselves. Then, to hedge their market exposure, the brokerages sell short.
BURNED. Still, it's too early to expect a return to the salad days of short-selling, when pension funds and other institutions were pouring money into short-only limited partnerships. The granddads of them all, the Feshbach brothers of Palo Alto, Calif., now run a hedge fund that goes long and short, instead of their traditional short-only strategy. The biggest short nowadays is Jim Chanos, whose Kynikos short-selling partnership fell some 40% last year--only to rebound by a like amount this year. (Chanos, in keeping with the publicity-shy character of the short-selling community, declined comment on his performance.)
Institutions are unlikely to come flocking back to shorts even if 1994 turns out to be a good year for the bears. They were too badly burned by their venture into short-selling in the recent bull escapade. The behemoths may come back, but only if the market miasma continues through the decade. Murphy, for one, is catering to the institutional prejudice against shorting in his newest enterprise--an S&P 500 index fund adjusted by removing its 30 most overvalued stocks. "Institutions want to take advantage of negative information, but they still shy away from short-selling," says Murphy. And given the big boys' atrocious record at market timing, maybe it's time to give short-selling another look.