Well I don't think that one has to be quite so binary about it.
I do agree that shorts have a couple of grave problems. The potential downside is bigger than the upside (I don't do classic shorts though, I just buy bear certificates, hence limiting my downside to 100% like with a normal stock (actually, a little less than that, since they'll usually cancel the certificate at some low level)). You don't get dividends – instead you have to pay continual premiums.
However, I don't see why a participant in the capital markets should necessarily refrain from what Benny Gram called "Intelligent Speculation" altogether. Especially if valuations are very high (and a crash will always hurt value stocks too, often even more), I feel like a long/short strategy is a quite natural way to hedge one's portfolio. More so now than ever, when the bond market is effectively mostly out of play. In a way, you're betting against yourself: your general bet is that Jordan's Bulls will win, but you make a small bet that they lose.
That one should never be 100% long stocks, especially not in an expensive market, is something so rare as an economic ground rule that almost everyone agrees upon (Graham too, of course). (Diversification being another one, into which I think this form of shorting falls.) Of course, one may do with that part of one's portfolio as one wishes: for me, it seems rather logical that if I'm long the undervalued stocks of the market, I can hedge that by being short the general market, if the market generally is overvalued. And – albeit more risky – short specific stocks that are in the most overvalued centile.
Individual shorts should probably never make up more than 1 % of ones portfolio, and shorts generally probably not more than 5-10 %. Cash is viable too, although it also has the "diminishing value and no dividends" problem. Precious metals, sure. "Alternative investments", maybe, why not. As long as one doesn't make one single risky investment (or all one's risky investments together for that matter) a large part of one's portfolio. Anything that spreads the risk when the overall market seems especially risky. |
