8/22/2013 5:15 PM ET|
Rising market slams short-sellers
Equity hedge funds are doing fine with their long positions but are 'getting killed' on the short side, with some experiencing their biggest losses in more than a decade.
Short-sellers are facing their worst losses in at least a decade, a Wall Street Journal analysis has found, as many of the rising stocks they bet against have only continued to soar.
In the Russell 3000 ($THX) index, the 100 most heavily shorted stocks are sharply outperforming the average returns of stocks in the index, according to an analysis of data provided by S&P Capital IQ. The shorted stocks are up by an average of 33.8% through Aug. 16, versus 18.3% for all stocks in the index.
The gap between the performance of the most-shorted shares -- as measured by percent of total shares outstanding at the beginning of the year -- and the market as a whole is wider than it has been in at least a decade.
"If you just took hedge funds' long positions, you would have pretty stellar performance," said Greg Dowling of Fund Evaluation Group, a Cincinnati-based investment firm that invests client money in hedge funds. "It's on the short side where guys have been getting killed."
Stock hedge funds are expected to outperform when markets fall but underperform during bull runs, since they generally hedge their bets by betting against stocks.
But the gap is wider than usual. Through July, stock hedge funds returned 7.7% on average, compared with 19.6% by the Standard & Poor's 500 Index ($INX), including dividends.
In short-selling, an investor sells borrowed shares in hopes of buying them back later at a lower price, and pocketing the difference. When the price goes up instead, the investor suffers a loss.
To some managers, the current dynamic is reminiscent of the final days of the dot-com bubble, when stocks continued to rise despite high valuations of many Internet companies.
"It's actually more painful now than it was in '99," said veteran short seller Andrew Left of Beverly Hills, Calif.-based Citron Research. He called the outperformance of widely shorted stocks this year "a fairy tale" driven by institutions chasing returns.
A losing trade for Left since July has been electric-car maker Tesla Motors (TSLA), one of the most heavily shorted stocks in the market. Tesla's stock price has gone up 353% this year, including a 76% rise since May 21.
A Tesla spokeswoman declined to comment. In April, Tesla CEO Elon Musk jabbed on Twitter at doubters: "Seems to be some stormy weather over in Shortville these days."
(Article continues below video)
Waiting for the market
Other heavily shorted companies that have kept rising are Zillow (Z), up 199% this year; Questor Pharmaceuticals (QCOR), up 157%; and Green Mountain Coffee Roasters (GMCR), up 100%. Green Mountain declined to comment; spokespeople for Zillow and Questcor said the short sellers often didn't understand their businesses or were focused on short-term price swings in the stock.
As happened with the Internet boom, Left and other managers believe their short positions will be proved right -- eventually.
Meanwhile, some hedge funds are posting lackluster results.
Hedge-fund Dialectic Capital Management told investors in a recent letter that its heavily short-biased fund was down 13.3% for the year through July, with a 6.3% loss in July alone. Its flagship fund, which is market-neutral, was down 3.7%. The firm managed $830 million at the end of last year, according to a regulatory filing.
Dialectic, which has bet against stocks including Herbalife (HLF) and Nu Skin Enterprises (NUS), according to a person familiar with the firm, is exiting some money-losing short positions and focusing on investments with a better chance of paying off soon.
"In a raging bull market, we just can't wait around for the market to realize we are right," its letter to investors said.
Nu Skin's share price has more than doubled so far this year. A company spokeswoman said the company had "strong fundamentals."
Herbalife's stock price has roughly doubled this year, also creating losses for Ackman's Pershing Square Capital Management, which announced a more than $1 billion bet against the company in December.
Ackman defended his investment on Aug. 20. "Herbalife is a pyramid scheme," he said. "We've not learned one fact that is inconsistent with that conclusion."
Herbalife has rejected Ackman's allegations and said it is a legitimate business. An Herbalife spokesman said "the facts clearly do not support" Ackman's short position against the company.
Funds that have performed better still have been hurt by their short bets.
The $2.1-billion Lakewood Capital Management, based in New York, returned 0.1% in the second quarter, with the firm's gains from bets on stocks largely canceled out by losses on short positions. Through Aug. 9, Lakewood had gained more than 8%, according to a person familiar with the firm.
"It has been a challenging period for short selling in recent months with companies of questionable value regularly registering impressive stock price gains, often in the absence of any meaningful positive developments," wrote Lakewood founder Anthony Bozza in a July investor letter.
Einhorn's $8.8 billion Greenlight Capital returned 1.2% in the second quarter, and gains in July were nearly halved by losses on shorts, according to communications with investors. For the first seven months of the year, the fund rose 10.7%.
Greenlight has been shorting Green Mountain, whose shares slumped after Einhorn raised questions about its growth prospects in the fall of 2011. But the shares this year have risen briskly.
Investors and managers say the shorted stocks that are outperforming are getting a boost from hedge funds covering their shorts, or buying back shares at a loss, in what is known as a "short squeeze" when it happens en masse. That in turn pushes the stock price higher.
Some short sellers expect the end of the Federal Reserve's massive bond-buying program to drive down share prices of certain companies. Already in August, the markets have experienced consecutive down days that have helped short positions.But for most of 2013, small dips in the market have been followed by bigger jumps.
Bozza, of Lakewood, is waiting out the market. He wrote he had often seen stocks he was short -- whose share price had risen dramatically untethered to significant developments -- later collapse "in spectacular fashion."
That remains a possibility for Tesla, his worst-performing short, he wrote. "While we certainly respect the possibility we could be wrong here," Bozza wrote, "our continued evaluation of Tesla has reinforced our conviction in our short position."
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A super great article. The Hedge Funds and their allies HFT fully deserve the battering they're receiving.
For over two years they have depressed the market with their short sale strategy at the expense of the small investors. They have made a ton of money with a strategy which encourages declining prices thereby creating and nurturing the uncertainties and fear impeding the rate of recovery which the small investors were desperately seeking.
One day these hedgies will realize and accept that the reason a stock price is moving against their position is usually because they’re in it. That’s true whether their position is short or long. There is always some other BSD in the market with more money to squeeze you out of your position. Icahn eats Ackman, then Soros eats Icahn, and so on and so on. Sadly for the rest of us, that is largely what the market in these fast, hot money stocks du jour has become. It has nothing to do with underlying value, fair trading, or efficient allocation of capital to good businesses. It’s just a battle of the titans with the biggest bank rolls to see who can bankrupt the other guy by squeezing him out of his position first. If you aren’t one of those titans, I would stay as far away from any of these stocks as you can get, unless you like being a squeezee.
While shorting a stock can bring your portfolio some good cash flow, it also lowers the overall value of that portfolio. And while this is one of my favorite things to do to the 'big boys' so I can redistribute the profits within my own community, I also am very selective on which equities I short.
Apple for example, has been rising consistently since coming off it lows. I see this this company doing quite well going into the fall & winter- folks will be snapping up those new phones for Christmas.
Shorting is just ONE tool in your 'toolbox', not the 'fix all', solve everything for you method.
You also expose yourself to lose much more than just your initial investment, so this should not be your everyday method of trading.
What comes around, goes around. Shorts will make a killing soon. And the herd that is long, well... they've now got it coming and great will the fall of it be.
To be long in this equities market with all the warning and caution signs is ludicrous. Don't these bulls see it as a bubble? A cheap money, Fed induced, glorification of excessive optimism. Well enjoy the top of the rollercoaster today, for tomorrow is all downhill and the ride will have been spent.
The fools still in the market, ALL think that THEY can out before it crashes from all the phony fiat money, but as usual MOST of the small fry are going to get caught.
Some have better computer programs than others, the best programs win. Real money is not talking with or telling others what they are doing. We know nothing about what big money is, where it is, or what's going on. Big money wins.
Good Luck to all of us little folks.
Big danger is Uncle Sam, he can change the rules at any time and never tell us.
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