Interesting article on Shorting--Provides some options available.
SMARTMONEY.COM: To Short Or Not To Short
Dow Jones News Service ~ April 12, 2000 ~ 8:00 am EST
(This report was originally published late Tuesday.) By Lewis Braham
NEW YORK (Dow Jones)--To short or not to short? That is the question. Whether 'tis nobler in the mind to face the slings and arrows of outrageous tech valuations or to take short positions against a sea of irrational exuberance and by opposing, end it. OK, I'm not Shakespeare, but Hamlet was a little too melodramatic for me anyway. There are always more than two options. Hamlet could've stayed in England instead of returning to Denmark, or he could've taken Prozac.
In the mutual fund world there are thousands of options for those depressed by current technology stock valuations. For instance, you could buy Potomac OTC/ Short (POTSX), which attempts to return the inverse of the Nasdaq 100 index or ProFunds UltraShort OTC (USPIX), which doubles the inverse of it. But that's shorting with a blunt instrument, or, as Hamlet would say, a bare bodkin. If the Nasdaq defies expectations, as it has so many times before, you could end up with a very bloody bodkin during a technology surge. I prefer a more conservative hedge, one that reduces volatility by pairing long and short positions to fit your temperament. Find your bias and pick your strategy from the table I've developed below.
Why short at all? If you're a pessimist, the reasons are obvious. The Nasdaq 100 currently trades at a ridiculous 161 times trailing earnings and is as jumpy as a kangaroo. When the Internet bubble finally bursts, you'll make a killing. But even if you like tech, shorting can dampen the volatility in your overall portfolio. The key is to make sure your longs differ from your shorts so your portfolio is hedged against downturns without nullifying possible gains. To assist you, I've spoken to six different managers from four tech and two long- short funds, asking them which areas of the tech sector are most vulnerable to a correction right now and which can weather a storm.
All six managers agreed that consumer e-tailers like Amazon.com (AMZN) and Etoys (ETYS) will continue to go down. One major reason is that traditional bricks-and-mortar companies are aggressively moving online. 'We call it the revenge of the incumbents,' says manager John Leo of Northern Technology (NTCHX) , one of the best-performing tech funds over the last three years. 'Wal-Mart ( WMT) is spending money on the Web space, and they have a lot of money to spend. That creates more pricing pressure and margin pressure on the online world than these type of companies were expecting.'
But a bigger no-no was negative cash flow. Young tech companies with no earnings depend on the capital markets for financing their businesses. But in a rising rate/declining market environment opportunities for secondary offerings and borrowing dry up. 'If the window to financing closes, there will be a big shake up in these companies,' says manager Doug MacKay of Red Oak Technology ( ROGSX). Money losing enterprises dominate all of the dot-com world - e-tailers, online-content providers and the hyper-inflated business-to-business or B2B stocks. 'I own a little bit of Ariba (ARBA), which is an early leader,' MacKay says. 'But the B2B space will continue to be volatile. Commerce One (CMRC), BroadVision (BVSN), Purchasepro.com (PPRO), Silknet (SILK) - there's probably going to be a shakeup there.'
Rather than short individual Internet stocks, you could easily buy Potomac Internet Short (Sorry, no snapshot available) which inverses the return of the Dow Jones Composite Internet Index. The index includes 15 e-commerce stocks like Amazon, eBay (EBAY) and Priceline.com (PCLN), and 25 Internet-service companies, including all the major B2B stocks like Ariba, Internet Capital Group (ICGE), BroadVision and Commerce One. Twenty-four of the index's 40 stocks have zero or negative cash flow over the past twelve months, and the index's median price-to- sales ratio is 60, according to Morningstar. That compares to an average 3.7 P/S for the S&P 500. A worthy short candidate.
For more precision, though, you could short one of Merrill Lynch's new holding company depositary receipts such as Internet HOLDRS (HHH), which focuses on e- commerce, or B2B HOLDRS (BHH), whose focus is obvious. Holdrs each contain a basket of about 20 stocks in their chosen specialty. Eleven of Internet Holdrs 19 stocks have negative cash flow over the past twelve months; 13 of B2B's 20 stocks do. Because they trade on the American Stock Exchange Holdrs can be sold long or short like any other stock. But just like any other stock, short-sold Holdrs can lose more than their initial-investment value if their shares rise more than 100%. Don't forget, you can never lose more than 100% in an open-end mutual fund like Potomac's short-selling funds.
Now, you've got to match those shorts with a long position in technology. One option is Red Oak Technology. There is surprisingly little overlap between the fund and Potomac Internet Short - less than 8% of Red Oak's portfolio. MacKay prefers Internet infrastructure, semiconductor and software makers - Cisco ( CSCO) Sun Microsystems (SUNW), Microsoft (MSFT) and EMC (EMC) - market leaders that have earnings, not untested dot-coms. A 50/50 weighting in these two funds would capture all the upside of the sector's strongest names, while hedging against its weakest links. Another strategy would be to hold a two-thirds long position in Icon Technology (ICTEX) and one-third short with Potomac or one of the Holdrs. Icon - believe it or not - looks for value stocks in the tech sector and doesn't buy companies with negative earnings. 'I don't even look at those dot-coms,' says lead manager Craig Callahan. For this reason, while the average tech fund fell 13.5% in the turbulent past month, Icon only declined 2.7%. But it may not soar as high during speculative upswings - hence the two-thirds long position.
Or you could hold individual tech stocks along with a short fund. Almost every manager I spoke to felt big franchise names would hold up better during a bear market. Manager Huachen Chen of Dresdner RCM Global Technology (DGTNX) recently increased his weightings in Dell (DELL), Intel (INTC) and Oracle (ORCL). 'People understand Intel a lot better than they do B2B,' he says. But you would be wise to combine these with some value-oriented plays. Almost one-quarter of Icon Technology's portfolio is in cheap electronics components distributors like Arrow Electronics (ARW), Avnet (AVT) and Grainger (GWW), which have price-to- sales multiples as low as 0.4. Northern Tech's Leo says data processing companies like First Data (FDC) and Computer Sciences (CSC) trade at 'untech like valuations and are potential safe havens.' Almost every manager also said, although not cheap, chip makers like Maxim Integrated (MXIM), Linear Technology (LLTC) and Conexant (CNXT) were reasonably priced relative to their growth rates.
As for shorting individual stocks, I wouldn't recommend it for novice investors because of the unlimited downside potential. 'The market's so dysfunctional you've got to be careful,' says David Tice of Prudent Bear Fund ( BEARX). 'You should diversify your shorts.' That said, there are some very tempting individual opportunities. According to Morningstar, there are currently three tech stocks with no earnings that trade at upwards of 20,000 times sales: Wave Systems (WAVX), Netpliance (NPLI) and Elot (ELOT). They'll have to produce God in a bottle to deserve those valuations.
There is, of course, one final option for dealing with tech volatility. Don't buy any technology. 'Why try to squeeze something out of an old has-been?' says Icon's Callahan. 'I think the money's moving out to other sectors. Airlines are really moving lately.' But if investors are compulsive like Hamlet, they'd sooner be driven to Silicon Valley than take a plane to Denmark.
For more information and analysis of companies and mutual funds, visit SmartMoney.com at smartmoney.com
(END) DOW JONES NEWS 04-12-00
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