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Some Thoughts on Shorting

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September 15, 2010 – Comments (14)

I've been writing a fair amount about short-selling lately, as have a number of other Fool writers. Here are a few of my most recent articles on the topic:

- You Won't Make Friends by Shorting Stocks

- Will You Profit From the Next Subprime Meltdown

- Is Shorting Stocks Foolish?

- Beware of These 5 Dangerous Stocks

 

A few (or maybe more than a few) readers have caught on to the not-so-hidden fact that the stream of short-related articles on Fool.com has coincided with the launch of a new short-focused newsletter. 

Now don't get me wrong, I totally understand the cynicism. The Fool, a bastion of long-term investing is suddenly touting short-selling. Sounds fishy. I actually addressed this in "Is Shorting Stocks Foolish." But even past that, there's the potential question of whether I'm actually interested in shorting or whether I'm just writing about it because of the product launch.

Here I figured I had a more informal venue to muse about why I (and that's just me as distinguished from any other Fool writers that have been writing about short-selling, whom I can't speak for) have been writing about shorting.

Basically, I heard the rumblings that we were going to have a short-focused product and I saw the articles that were starting to come out talking about shorting. I wasn't really taken with the whole deal -- after all, I generally focus on high-quality buy-and-hold dividend investments.

But I thought about it, I talked to some of the people working on the product and I came around to the idea. Not that I'm bearish. Not that I want my whole portfolio to be shorts. And certainly not that I'm going to abandon my core investments.

What I liked was the idea of setting aside part of my portfolio for shorts, giving myself a different type of exposure. Plus, I love the idea of being skeptical and digging up companies that are ill-managed or less-than-above-the-board.

I hardly think shorting is for everyone and, in fact, I think that I'd probably want to spend significantly more time digging into a short than I would for a long investment. So whereas long investing requires a significant time investment, shorting increases that. 

The bottom line, though, is that I wanted to clarify that I'm not writing about shorting because anyone has said "Fool.com writers need to write about shorting" or "your job right now is to write about shorting." After sniffing around, I liked the idea, so I decided to write some articles about it. Hopefully some readers were able to get something out of those articles -- after all, even if you have no interest in shorting, I think it could be very beneficial to look at your long holdings from the eyes of a potential short seller.

Now, I'd love to hear your thoughts...

 

Matt

14 Comments – Post Your Own

#1) On September 15, 2010 at 10:49 PM, portefeuille (99.65) wrote:

I hardly think shorting is for everyone and, in fact, I think that I'd probably want to spend significantly more time digging into a short than I would for a long investment. So whereas long investing requires a significant time investment, shorting increases that.

I think it usually does not matter how much time someone spends on either one. If it does, that person should probably make investing his profession. 

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#2) On September 15, 2010 at 11:59 PM, starbucks4ever (98.71) wrote:

Who wants to bet how long this new product will last before it's discontinued because of the ugly-looking red on the scorecard?

My guess is 10 months at most. 

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#3) On September 16, 2010 at 1:10 AM, TMFKopp (97.82) wrote:

@zloj

I think healthy skepticism is a good thing to have when it comes to investing. Though (to your blog post) I'm not sure anyone's saying that shorting is an easy path to riches. It's just another tool for the investor's toolbox.

Matt

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#4) On September 16, 2010 at 1:10 AM, TMFKopp (97.82) wrote:

@portefeuille

I'm not quite sure I follow...

Matt

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#5) On September 16, 2010 at 11:43 AM, starbucks4ever (98.71) wrote:

"Though (to your blog post) I'm not sure anyone's saying that shorting is an easy path to riches. " 

Really?

----------------------------------------------------------------- 

"Here's another reason not to wait until the 11th hour to decide: Today, Thursday, September 16, at 2 p.m., I will release my first official Motley Fool BIG Short recommendation. This is a high-conviction, thoroughly researched short opportunity that could play out in a matter of days."

 "Don't worry. I'll explain everything in the next few pages. Including how... with a few commonsense tweaks... you can adopt John Paulson's hyper-analytical approach and make more money investing, more quickly, and WITH MUCH LESS RISK."

"Because if my models are correct, the quality of corporate earnings flowing through Wall Street will hit a NEW LOW before you finish reading this invitation."

"

Betting against low-quality stocks in this market
is like shooting fish in a barrel"

"That revelation changed my life forever."

" Shorting is a niche discipline even on Wall Street (my experience is that one in 50 professional investors has the foggiest idea how to go about it)"

"

 

The simple revelation that stops the pros in their tracks..."

"Ninety-five percent of the professional investors I meet with are completely unaware of the daunting odds I just shared with you"

"

The age-old scandal that essentially
puts money in your pocket ..."

"this imbalance contributes to inefficiencies in stock pricing -- almost always on the short side."

" this creates a massive untapped opportunity for opportunistic investors."

"Wall Street analysts are brainwashed bulls"

"The final, and most insidious, reason it's easier to make money selling stocks short than buying stocks "

"I don't exaggerate when I say that shorting low-quality stocks in this market is like shooting fish a barrel."

"Why not choose the easier path? It worked for Jim Chanos... it worked for George Soros... and it just worked for John Paulson to the tune of $3.7 billion." 

Enough? 

 

 

 

 

 

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#6) On September 17, 2010 at 6:32 PM, TMFKopp (97.82) wrote:

@zloj

Fair enough. But that sounds like marketing materials, and marketing is marketing. I was more referring to the stuff that has been posted on the Fool.com site. 

I'm curious though... Here's the most recent post from your Fool.com blog:

"Second oil short

September 17, 2010 – Comments (0)

XLE @54.34 "

 

So obviously you don't have a problem with shorting in general. Why so angry that TMF is starting a short-selling service?

Matt

 

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#7) On September 17, 2010 at 6:59 PM, starbucks4ever (98.71) wrote:

Yes, I anticipated that question. Because only a fool makes general statements without nuances. Making money on the short side is not impossible. But to say it's like shooting fish in a barrel is incredibly misleading. It is no different from the Dow 36000 talk. Even though I may open a short once in a while, the fact remains that it's always a difficult endeavor, more difficult than profiting from long positions, and we've seen in the past 10 years that profiting on the long side is not exactly easy. Marketing is marketing, but anyone who buys into this Big Short thing because they read that's like shooting fish in a barrel, should not be in the market. Period, end of story.   

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#8) On September 17, 2010 at 8:29 PM, TMFKopp (97.82) wrote:

@zloj

"But to say it's like shooting fish in a barrel is incredibly misleading. It is no different from the Dow 36000 talk."

I just don't agree with that. Two reasons... both pretty different.

1) I like the idea of setting aside a portion of my portfolio to work with shorts. This doesn't require a wholesale decline in the market, it just requires that you find a handful of companies that have something ugly going on that's going to bring the stock down. In an overpriced market (like 2000 or 2007) you can still find worthwhile longs and likewise I think that in a reasonably priced market (I'd give that to today's market) you can find worthwhile shorts.

2) John, who is running the newsletter, has been a short-focused investor for around a decade. Based on what I've heard he's been very successful doing that and the stuff that I've read of his is very compelling (we're talking shorting-focused information, not marketing).

 

Marketing is marketing. I've always had a somewhat strained view of our marketing for that reason. But the fact is that I feel the same way about marketing for so many other products and services all over the economy. 

And that's not to mention that signing up subscribers for TMF newsletters -- which overall have performed quite well and have provided lots of opportunities for learning for subscribers -- allows The Fool to continue to offer great free content and services (like CAPS). 

Matt

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#9) On September 17, 2010 at 8:35 PM, TMFKopp (97.82) wrote:

Oh, and one more thing on the "shooting fish in a barrel" thing.

Maybe finding shorts is like shooting fish in a barrel for John right now. Throwing a dead-accurate 50-yard pass may seem pretty easy for Peyton Manning, it doesn't mean I'm going to be able to do it.

If people read that marketing material and decide that it's going to be easy to find and execute shorts on their own even though they've never done it... well, yeah, that'll probably end badly. But then again, assuming that you, without training, can do anything as well as somebody who's trained and has years experience is just silly.

On the other hand, somebody might read that and say, "This guy John sounds like he knows what he's doing, I'm going to give him a shot." In that case, I think they might learn a lot from following along with the newsletter. Obviously I can't speak to what performance will be like, but it's no different from jumping into a new or young mutual fund. Except, of course, you're usually not going to get a new mutual fund advisor to give you his inside thinking to all of his picks...

Matt

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#10) On September 17, 2010 at 10:09 PM, starbucks4ever (98.71) wrote:

Hi Matt,

I certainly can't argue with your first point. We both agree that a small short position (5-7% of the portfolio) may be all right for sophisticated people. Can one publish newsletters devoted to shorting? Absolutely. But I disagree with your second point about it being marketing as usual because:

a) The sales pitch has been unusually intense even by the Fool's previous standards. Even people at Stock Advisor - the one team that actually had a decent track record - never allowed themselves such self-congratulatory tone of voice.

b) Some of the points made in the promotion clearly look like misrepresentations. I have given you the quotations. Now perhaps some highlighting will be warranted.  

make more money investing, more quickly, and WITH MUCH LESS RISK 

Oh really? You really think that short-sellers make more money, more quickly, and with less risk? Do you have any historical studies to prove this point? If some short-sellers had a strategy that works better than average, then greatest fortunes on Wall Street would be made on the short side. This is obviously not the case.

"my experience is that one in 50 professional investors has the foggiest idea how to go about it"

Say what? Is he saying that 98% of professional investors only know how to work with longs? Google "how many hedge funds are there", perhaps that will make you feel more realistic.  

this imbalance contributes to inefficiencies in stock pricing -- almost always on the short side 

Huh? What a strange thing this stock market is! Stocks are almost always ready to drop, offering juicy rewards for the shorts, and yet the long-term chart goes up at 7% a year. The inefficiencies are on the short side, but the gains accrue to the longs. What an irony! 

Why not choose the easier path? It worked for Jim Chanos... it worked for George Soros... and it just worked for John Paulson to the tune of $3.7 billion 

Again, what an irony! Buffett chose the more difficult path, and became richer than Chanos, Soros and Paulson combined, who chose the easier path. Maybe the concentration of geniuses on the long side was higher than on the short side? Or maybe when you think about it, the "easier" path was not so easy?

c) The Fool's headlines (whose authors suddenly and simultaneously became converts to the new religion) never did once mention the essential truth that John's fellow-travelers would be treading upon the much more slippery ground than subscribers to "long" newsletters. This admission is, in my opinion, necessary, and it would not stop the marketing effort. The Fool can still extol John's skill and track record. But it's (f)oolish to not say a word about the objective features of the landscape which are outside John's control. If I am running uphill, I can still ask people to bet on me finishing first, and it wouldn't be a lie. But it would be misrepresenting things if I imply that running uphill is easier or that my track is actually level or going down.

So for these reasons I posted my opinion, namely, that people should realize that the odds are staked against the shorting team and that the kind of gains promised in the ad could come only through exceptional skill or exceptional luck or both. And my opinion is borne out by the entire 200 year history of the markets. Which doesn't mean of course, that every now and then someone will not strike it rich. 

By the way, we don't know how well John actually performed in the past decade although the ad mentions that he once made 98%.

And we are talking about the second-best decade for shorting ever, the post-dotcom-bubble decade. The decade before it saw many thousands of short geniuses lose their shorts, pun intended, on what were very sensible, very well-researched bets. Just because it happened long ago, people imagine it can't happen again. It can, and will. 

 

 

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#11) On September 18, 2010 at 1:01 AM, TMFKopp (97.82) wrote:

@zloj

Look, it's going to be hard for me to argue about what's been said by the marketing emails. I'm not in marketing, I don't write those emails, and I've never once been asked for my input on them. 

I could probably make some counter-arguments on some of the points you make, but your points are mostly valid -- at least as far as saying "yes, they do look like aggressive statements." I don't know that I'd go as far as saying misrepresentations, but aggressive, yes.

All I can really speak for is what I've written, and what I've written is based on my interest in discussing the merits of adding short selling as another tool in an individual's investing toolbox.

And was this inspired by the fact that we had this new service coming out? Yup. But I wrote the articles because I decided I actually liked the idea and plan to follow along with the newsletter myself. 

Well... I think that's how it went... Unless The Motley Fool got Leo DiCaprio to go into my dreams Inception-style and plant the idea in my head that I'd like the idea of short-selling. But if I find out that's the case I'll be very angry and I'll be sure to let you know.

Matt

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#12) On September 18, 2010 at 1:05 AM, TMFKopp (97.82) wrote:

Oh, and as for mentioning that it's a bad environment for shorting... well, I'm not so sure that it is. At the risk of sounding cliched, the current market strikes me very much as a stock-picker's market -- not particularly undervalued, and not particularly overvalued. I think you've got to be picky about your longs and your shorts, but both opportunities are there.

And I think depending on the extent to which John and his team are able to find solid catalysts to put the brakes on the companies they're recommending, they can cetainly succeed even in a rising tide. 

But of course the proof will be in the pudding. The results of all the newsletters are stacked against the S&P so if John's results aren't worthwhile... we'll know.

Matt

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#13) On September 18, 2010 at 1:43 AM, starbucks4ever (98.71) wrote:

Let's wait for the pudding. John's chance to deliver on the promise is greater than zero - that's the good news. But for that he'll have to be a better stock picker than the other newsletter teams. If he is only as good as Income Investor team, he will lose money, and if he's as good as Stock Advisor team, he'll break even. If he has exceptional talent, he should manage it all right.

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#14) On September 20, 2010 at 4:22 AM, TMFKopp (97.82) wrote:

@zloj

That's the spirit! :)

Seriously though, we're not that far apart on how we feel about the advertising. I do, however, think that TMF has done pretty well overall picking advisors to head the newsletters. And, more importantly, with every new newsletter I believe their foremost concern is always whether subscribers will be better off for signing up.

Even if you look at that latter point from a cynical / business view -- if TMF continually were to open lousy newsletters it would be bad for business... to say the least.

Matt

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