Short Sellers Receive a Break
But Struggle to Gain Benefits
By ROBERT MCGOUGH
Staff Reporter of THE WALL STREET JOURNAL
Some of the stocks that short sellers love to hate have finally declined -- but a lot of these doubting-Thomas investors have been either too scared, or too broke, to short them.
The past 4 1/2 years, which have been a boon to so many investors buying stocks, have been a disaster for most short sellers, who profit when stocks go down. Short sellers sell borrowed shares, in the hope they can buy them back at lower prices and pocket the difference. Sharply rising stock prices have handed these "shorts" extensive losses.
Last year, an index of short-selling managers, compiled by Harry Strunk, an investment consultant in Palm Beach, Fla., who tracks short-seller performance, declined 11.51%. The Standard & Poor's 500-stock index, in contrast, had a total return of 28.58%, including those teeny dividends that companies pay nowadays. This year through June, the short-seller index has fallen an additional 3.87%.
But since the spring, some of the short sellers' favorite targets, Internet stocks, have been dropping. Internet-related stocks are a favorite target of short sellers because of their sky-high prices relative to sales and, if they have any, earnings. Yahoo! has fallen from as high as 244 in March to 136 7/16 Friday on the Nasdaq Stock Market. Shares of eBay have fallen to 97 11/16, also on Nasdaq, from 234 in late April. America Online has fallen to 97 1/8 from as high as 175 1/2 in the spring on the New York Stock Exchange.
So why haven't more short sellers been making hay on the Internet's decline? Because they tried so many times before -- and got burned. Some Internet stocks that have attracted shorts, such as Network Solutions, trade for less now than at year end. But many Internet stock prices are still up sharply since Dec. 31: Shares of eBay, for instance, are up some 21% this year.
"Shorting the Internet stocks has not been a healthy thing to do this year," Mr. Strunk says.
David Tice, manager of Prudent Bear Fund, agrees that "you had to be extraordinarily skilled tactically to do well" shorting Internet and tech stocks this year. While Amazon.com has declined, "you had to be out of the way at the right time" when it was rising. Moreover, tech stocks tied to personal computers, such as chip makers Intel and Micron Technology, have shown a discouraging [to short sellers] resistance, Mr. Tice says. "Micron fell quite a while, but it rallied significantly since then," he says. Other managers cite strength in Dell Computer and Gateway as having tripped them up. Prudent Bear Fund, a mutual fund that frequently shorts stocks, had a negative total return of 19% this year.
One problem that Mr. Tice and other short sellers complain about: The stocks they are trying to short seem to run up sharply in a burst of enthusiasm (or, perhaps, a "short squeeze") right before they decline, making them difficult to short profitably. Other money managers complain that their prices seem to run up at the very end of the day before the close.
In this difficult environment, says Michael Murphy, editor of the Overpriced Stock Service newsletter in Half Moon Bay, Calif., "most of the short sellers have gotten very good at putting very tight 'stop losses' in," that is, closing out their losses when stock prices rise to a certain level instead of letting the losses grow.
One area that has made money for short sellers recently has been airline stocks, which have declined because of rising fuel prices and unused capacity. The stock of US Airways Group has fallen to 35 5/8 from 64 in January on the New York Stock Exchange. UAL, parent of United Airlines, has dropped to 63 7/16 from 87 3/8 on the Big Board.
But in many cases, short sellers have steered clear of large, blue-chip stocks, which have outperformed smaller stocks for four years running, and which they charge rise simply as money flows into index funds.
Despite occasional successes, rising stock prices overall mean it is still a tough slog for short sellers, who take umbrage at the prices investors are willing to pay now for stocks. "The U.S. economy has been in an unusual sweet spot for the last several years," hedge-fund manager (and frequent, though not exclusive, short seller) David Rocker wrote to partners of his hedge fund in its second-quarter report. Mr. Rocker's partnership had a loss of 1.9% in the second quarter but gained 29% in the first quarter (both returns are after fees). But Mr. Rocker reported signs that the positive "trends appear to be reversing," and "the persistence of this favorable climate must now be questioned."
Hope springs eternal.
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