Fisher Investments Editorial Staff
US Economy

“Short”-comings

By, 05/04/2010

Story Highlights:

  • European nations and the IMF agreed to provide Greece a very generous €110 billion ($147 billion) rescue package, hinging on final approval from national governments.
  • Things appear less rosy for some hedge funds who bet short over the last year or so—from February 2009 to now, hedge funds holding short positions lost 34% of their value.
  • Some see short-sellers as possessing some magical information helping them make bets against stocks, but these market players are prone to the same errors long investors can make.
  • Short-sellers are a natural component to markets and serve positive functions too—helping with price discovery and increasing market liquidity.

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What a difference a weekend makes. Just last week, at the hands of S&P, Greece suffered a downgrade of its sovereign debt to junk status—causing its bond yields to spike and reigniting fears of Greek default and European contagion. But as we thought likely, the benefits of union and costs of dissolution mean eurozone members are not going to stand idly by as Greece flails—and on Sunday, 15 European nations and the IMF agreed to provide Greece a very generous €110 billion ($147 billion) rescue package, hinging on final approval from national governments. 

While Greece got its white knight rescue, things appear less rosy for some hedge funds who bet short over the last year or so. Often villainized as stock price manipulators who reap large profits at the expense of other "normal" investors, short-sellers can, and do, lose money too. From February 2009—just before the bull overturned the bear—to now, hedge funds holding short positions lost 34% of their value. 

Some see short-sellers as possessing some magical information helping them make bets against stocks, but these market players are prone to the same errors long investors can make—like heat-chasing, only in reverse. For example, during the past year, short-sellers speculated most against financial institutions, restaurants, and retailers—confident these firms would either shutter or see profits weighed down by high unemployment. However, in the V-shaped market recovery, stocks that were battered the most rebounded the most. Plus, Q1 2010's earnings results thus far show Financials leading all S&P 500 sectors in y/y earnings growth. 

Short-sellers are like any other investor—trying to profit from unknowable future market movements. They are a natural component to markets and serve positive functions too—helping with price discovery and increasing market liquidity. And don't forget, in many ways, short-selling strategies can be riskier than long investing, especially in a rising market. (And stocks do tend to rise more than fall.) Long investors know what their potential losses are ahead of time because a stock can only drop to zero. But for short-sellers, a stock could go from $1 to $50, or $100, or $1000. They'll have to cover the short position eventually, no matter how high a stock goes. Plus, consider the opportunity cost of not being long when the market's rising. No doubt, shorting can pay off huge and can be a good tactic if you get successfully defensive during a bear market. But big reward and big risk are inherently interlocked. Sometimes risk goes the other way. 

During the bear market, hedge funds betting against stocks saw huge profits—and heavy federal scrutinizing as a result. But with rising stock prices and global corporate earnings strongly beating expectations as economies recover, short-sellers are now getting the short end of the stick (though we've yet to hear regulators discuss instituting downtick rules to protect them. We'll not hold our breaths).

  

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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