Short sellers--pariahs to some, a necessary balance against irrational exuberance to others--make their money the hard way: from falling stock prices. Driven from the mainstream investing landscape as the bull market set record after record in the 1990s, there are signs that their numbers are increasing.
Overall statistics on short selling are scarce, but experts say the practice has been quietly gaining momentum since mid-1999. The sharp declines of the past few weeks and overall market skittishness may put the strategy on the radar screens of more investors.
"The bear market has been a lot longer in coming than we anticipated," said David Tice, portfolio manager of the Prudent Bear Fund, a $160 million mutual fund that specializes in short selling. "But our investors are believers. They think--they know--there's a bear market coming. We've been waiting for this."
Their wait may be over. After surging 86 percent last year and another 24 percent early this year, the tech-heavy Nasdaq composite index has been pummeled recently.
This is a sampling of large and small tech companies and the percentage of their floated shares sold short as of March 8 by investors who expected the price to decline.
|Company||Percentage sold short|
The markets got another scare today after economic reports indicated that the economy is growing at a rapid clip and inflation is rising. At midday, however, the Nasdaq was moderately higher, while the Dow Jones industrial average was down.
For several months, many e-commerce shares have been shorted heavily by investors who bet they would collapse under the weight of their high price-to-earnings ratios (if they have any earnings) and difficulty in raising more cash. For these short sellers, the misery of many investors has been a long-awaited vindication.
In the past six months, for example, investors have poured about $20 million into Tice's relatively small Dallas-based Prudent Bear Fund, one of the best-known short funds. The 4-year-old fund has averaged annual declines of about 17 percent, but since January it's up about 13 percent.
Harry Strunk, a Palm Beach, Fla., investment consultant who tracks shorts, counted six mutual fund managers who specialized in shorting in March. The group is down an average of 8 percent for the past year but up nearly 15 percent since the beginning of March, Strunk said.
Many shorters are stepping into the spotlight as market conditions turn stormy. For most of the '90s they operated clandestinely, perceived as besieged traders who wagered on what to many seemed anti-capitalist and un-American: that stock prices would not always rise.
"The reason shorters are particularly despised is because they're rooting for someone to fail. It's not polite," said Russell Roberts, economist at the Center for the Study of American Business at Washington University in St. Louis. "But they're just saying that the financial future of this company is not as rosy as the current stock price indicates. Speculators perform a role in providing information and encouraging prices to reflect reality."
Shorters themselves agree. For many, the '90s bull market meant anxiety and humiliation. Many, including the well-known Feshbach brothers of Palo Alto, Calif., disbanded or started trading long. From 1990 to 1998, the number of full-time short fund managers was halved to roughly a dozen firms; now there are about six.
But the pendulum is swinging the other way now that the Nasdaq is full of e-commerce stocks that are, in theory, a shorter's dream--no profits now or anytime soon, high management turnover, high overhead and thin margins.
When the Nasdaq was at its peak in mid-March, shorters had already made large bets against numerous e-commerce and other tech companies. For example, more than one-third of the floated stock in TheStreet.com and Priceline.com had been sold short as of March 8. Among the highest ratios: More than 56 percent of Value America's float and nearly 83 percent of Autobytel's float had been shorted.
The shorters "think they're tremendously overvalued," said Benton Gup, professor of finance at the University of Alabama in Tuscaloosa. "They see no reason the prices are where they're at."
But quite often, e-commerce stocks can shoot higher for no apparent reason. Particularly infuriating and attractive to shorters is Amazon.com, the e-commerce bookseller-turned-general merchandiser that has yet to turn a profit but is starting to line some shorters' pockets.
Amazon stock was stuck at $8 per share (adjusted for splits) in the summer of 1998. In rapid succession, it split three times and exceeded $112 per share in September 1999. With 24.2 percent of outstanding shares sold by shorters, Amazon is now trading around $52.
Although Amazon has not predicted when it will become profitable, the company yesterday said it will have positive cash flow during the next three quarters combined and that it has $1 billion in cash.
Manuel Asensio, who runs New York-based investment boutique Asensio & Co., says he has wrung profits out of the bull market every year since 1996. The seeds of the '90s market rally--the Internet--will also be fertile ground for shorters, he said.
"The Internet is an ideal exchange of information concerning paper, insurance, stock, media properties and brokers. It's about creating buying groups and bidding processes," Asensio said. "For physical products, the Internet adds no value."
Despite harrowing times for many shorters, he said, regular investors should not ignore them: Shorters are early barometers for general market conditions.
"It's impossible for stock prices to be maintained at these levels," Asensio said. "Capitalist societies require companies that return reasonable returns and dividends. Companies like Amazon? Lord knows if it will ever make money. It's wildly irrational. That's why shorters love them."