Saturday April 7, 1:05 pm Eastern Time
Stocks View: Dance with the Bear
with Short Funds
By Brendan Intindola
NEW YORK (Reuters) - Have you lost faith, and money,
waiting for a stock market turnaround?
Then maybe it's time to join the short sellers, the bears who
have found a honey pot in the U.S. equity rout, profiting
from falling prices while most other investors are swilling
red ink.
Mutual funds that ``short'' the market, an easy way for
individuals to profit from market declines, have posted big
gains in recent months, as stock prices have declined.
By contrast, in the first quarter U.S. stock funds that own
stocks, or are ``long'' the market, have had the worst returns
in more than two years as the bearishness in technology
stocks spread to the broader market.
But when the market is dropping, short sellers come out on
top because they have borrowed stock and then resold it on a
bet the price will fall. If their bet is right, they can buy the
stock again after the price drops and then return it to the
lender, pocketing the difference as profit.
HEDGE LIKE THE PROS
Michael Sapir, chief executive of ProFunds in Bethesda, Md., a fund family with $2
billion in assets that includes the red-hot UltraShort OTC, said these types of
short-selling investments are best used as a tactical, short-term hedge within a larger
portfolio.
The UltraShort OTC fund, up nearly 62 percent in the first quarter, is an ``inverse
index fund'' with a stated goal of returning twice the opposite performance of the
Nasdaq 100 index (.NDX). If the Nasdaq 100 index falls, say, 50 percent in a given
period, the fund would rise 100 percent.
``It is like an index fund on a mirror,'' Sapir said. ``We can short individual stocks,
but that is not the most efficient way.''
Short-fund portfolio managers often rely on so-called ``put'' options, which act like
insurance policies by giving the right to sell a stock at a set price by a certain date.
Suppose IBM is trading at $92 per share and an investor thinks it will fall to $90 by
June. She might buy an IBM June 90 put, giving her the right to sell the stock at $90.
If the price goes to $82 per share, the value of that option would increase. If the stock
price rises, the investor would book the cost of the contract as a loss.
Similar instruments exist for equity indexes, like the Standard & Poor's 500,
allowing portfolio managers to make bets covering broad market moves.
``We think these funds are good short-term tools. We don't think they are
buy-and-hold funds. People are using these funds to hedge a portfolio, just like
professionals have been doing for a long time,'' Sapir said.
``So if investors believe in the long-term prospects for tech stocks and would rather
not sell, they may want to put a hedge on for three to six months. So you can have a
good hedge against a market decline. It limits your upside obviously, but it limits
your downside too,'' Sapir said.
WEAKNESS IN NUMBERS
U.S. diversified stock funds fell 13.1 percent in the first quarter, according to data
from mutual funds tracking firm Lipper Inc. The decline is the worst since the third
quarter of 1998 when Russia's financial crisis and the near-collapse of hedge fund
Long Term Capital Management drove markets lower.
An average of about a dozen U.S. short funds prepared by Lipper showed a gain of
28.6 percent in the first three months of 2001. And for the 12 months ended March
31, the average gain was 75.2 percent.
From all-time highs reached in the first quarter of 2000, the Nasdaq composite has
fallen 67 percent, the Dow is off nearly 19 percent and the S&P 500, the benchmark
for judging investing pros, is down nearly 28 percent.
A NEWER OPTION, NOT WIDELY KNOWN
Over the last six months to a year, Sapir said, there are many relatively new investors
who have not experienced such sharp declines in stock prices. These types of funds
were not available during the last bear market.
``Most retail investors do not know how to short the bear market, and they may not
have the margin account to allow them to short. And if you are dealing pension
assets, even down to the individual level in IRA accounts, generally you cannot short
these accounts, but you can buy mutual funds,'' he said.
PRUDENT BEAR: LOOK FOR DOW 3,000
David Tice, the Dallas-based manager of the Prudent Bear Fund, said he believes
U.S. stocks are just ``in the early innings'' of a significant decline.
Tice, whose $175 million fund gained nearly 16 percent in the first quarter, said he
expects the Dow Jones Industrial average to drop below 3,000 over the next 12 to 18
months, and the Nasdaq composite to skid to below 500 over the same time period.
The Wall Street establishment, however, is betting on a comeback by stocks,
although targets for major indexes set by the brokerages have been pared back
recently.
An average of year-end targets forecast by the major sell-side houses has the S&P
500 up 40 percent in 2001, the Dow gaining 33 percent, and the Nasdaq composite
rising 80 percent.
But in the bull-bear fight that is as old as the stock market, Tice swings a clawed paw
at the optimists. He points out the price-earnings ratio of the broad market -- or the
share prices of all S&P 500 stocks divided by the group's combined ``trailing''
earnings per share for the previous 12 months -- is still very high in historical terms.
``We started our fund (in 1996) because we felt the market was overvalued. We still
believe that we are just in the early innings of a decline,'' Tice said.
In bear cycles, as markets typically fall, rise, and fall again, price-earnings multiples
proceed from low to high and back to low, Tice said.
``Even with the Nasdaq down significantly, we believe this is nowhere close to a
bottom because we are selling at 24 times trailing earnings for the Standard & Poor's
500.'' That is only 6 notches lower than the S&P 500's P/E ratio of 30 at the market's
peak in 1999. In 1982, the ratio was as low as 7.
``It is like a pendulum -- you swing too far to the right, it is going to swing back to
the left. It was extreme euphoria that will probably end in extreme despair,'' Tice said.
What about the longer-term benefits investors are expecting from three interest-rate
cuts by the Federal Reserve this year to juice up the tottering U.S. economy?
Tice hearkened back to the bear market of 1973-74.
The conventional wisdom ``is after three cuts, the market has no where to go but up.
But, if you look at the 1973-74 period, by the time the market started higher, the
market was 70 percent off its highs and was selling at a P/E ratio of 7.''
The U.S. central bank lowered interest rates repeatedly over two years beginning in
late 1974. For the S&P 500, 1973 and 1974 are the only two straight down years
since 1950. The index fell 17.4 percent in 1973, and nearly 30 percent in 1974. As the
economy recovered, the S&P 500 gained 31.5 percent in 1975 and 19.1 percent in
1976.
While he declined to name specific short positions held by his fund, Tice said it is
``still short semiconductors, lots of tech companies, semiconductor equipment
manufacturers, and we are short financials -- subprime lenders, money center banks
and brokers.''
What areas of the market will be spared the further mauling predicted by Tice? ``We
think gold and silver mining companies will go higher, and defense contractors will
go higher,'' he said.
For the week, the Nasdaq Composite index fell about 120 points, or 6.5 percent to
1,720, the Dow Jones Industrial average lost nearly 90 points, or 0.9 percent, to 9,791
and the S&P 500 dropped almost 32 points, or 2.7 percent to 1,128. |
