Can You Short in a Bull Market?
September 21, 2010
– Comments (12)
In a previous post, zloj and I had a bit of a back and forth on the topic of TMF's new shorting service. The issue was continued on zloj's blog, where our exchange was reposted with zloj's emphatic thoughts that the service would be a miserable failure since the market is headed for more gains.
I actually don't disagree on that last point. So what gives? Can you still short in a bull market?
Since the Big Short will be taking a shorter time-frame on its moves, I stuck to one-year periods for what I looked at to be somewhat comparable.
Certainly the worst time period to check this against would be the recent bull charge off the recession lows -- that is, March 2009 to March 2010. And the results come out as might be expected -- the S&P 500 was up 52% and among stocks with a market cap of $250m or better, 92% were in the black. Ouch.
But that's pretty extreme. I don't see that kind of move ahead, and it doesn't seem like zloj, or anybody else with their head on straight sees that kind of juice in the year ahead.
So I looked at another year period that was also very bullish, but not quite so -- August 1998 to August 1999. During that stretch the S&P was up 34%. Of the stocks that were $250m or larger, 62% posted gains. Now that means you would have had a better chance of picking a gainer than a loser, however, it also means that a chimp with darts would have had better than a 1/3 chance at picking a short that would make money. I could only assume that a seasoned short-selling investor would have a far better chance than that. And that's during a particularly strong bull run.
Looking at one more positive stretch for the market, but not nearly as positive as the other two, I also pulled up the results for January 2005 to January 2006. The market gained, but only about 3%. During that year, you had a 53% chance of picking a stock that was in positive territory. In other words, your chances of picking a money-making short were nearly the same as a flip of a coin.
And of course none of this covers what happens if you decide to short against an index to make your returns from stocks that simply underperform that index. That changes the math considerably. Now during even the 3/09 - 3/10 period, you had about a 50-50 chance of picking a stock that underperformed. It was roughly the same during 2005. Interestingly, during the 1998 period, you had a 70%-plus chance of finding a stock that underperformed the S&P's 34% gain.
The bottom line is that I don't think you need to be a bear to be interested in adding shorts to your portfolio. Personally, I'm not really bearish at all, but I know that there are companies out there that are doing things that could lead to a stock-price tumble whether or not the market is charging forward.
Now will Big Short deliver incredibly amazing performance? Only Miss Cleo knows that. But I hardly think it's doomed just because the market may have some positive momentum ahead.
Matt
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