Blue chips looking more like cow chips to investors

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Big, blue-chip stocks are supposed to be a good place to hide out in a dicey market.

Not this time.

In Friday’s brutal Wall Street sell-off, the Dow Jones industrial average and Standard & Poor’s 500 index both suffered bigger percentage declines than indexes of smaller stocks -- continuing the trend of the last seven weeks.

The Dow dropped 220.40 points, or 1.8%, to 11,842.69. That left it just 0.9% above its 2008 closing low of 11,740.15 reached on March 10.

The Russell 2,000 small-stock index, by contrast, lost 12.10 points, or 1.6%, to 725.73. And it’s still 12.7% above its 2008 low, also reached on March 10.

‘Something is wrong with this picture,’ says Brian Gendreau, investment strategist at ING Investment Management in New York. ‘Small-cap issues are supposed to be riskier.’

In other words, if investors are seriously worried about the economy falling into a painful recession because of record oil prices, a badly wounded banking system and a spent-out U.S. consumer, they ought to find more comfort hanging out in bigger stocks than in taking a chance on smaller names.

Yet smaller issues outperformed the bigs in May, and the same is true so far this month.

Why are blue chips bearing the brunt of the damage in this market relapse?

Here are two possible explanations:

--Nervous institutional investors are in a hurry to raise cash, and when you’re in a hurry you sell your most liquid stocks. You always know you’ll find someone to buy your General Electric Co. shares, and at a price relatively close to where the stock is in the market at that moment.

But selling a small-company stock in a falling market is a much more difficult prospect, particularly if you’re trying to sell a lot of shares at once. You risk triggering a devastating price decline.

--Bearish investors who expect the market to continue sliding are targeting blue chips for ‘short’ sales, because they’re the easiest stocks to short. In a short sale an investor borrows stock from a brokerage and sells it, betting that the market price will fall. The idea is to repay the loaned shares later with stock bought at a lower price.

If the trade works out, you pocket the difference between the sale price and the repurchase price.

Michael Holland, head of investment firm Holland & Co. in New York, notes that big-name stocks’ liquidity makes them a breeze to borrow for short sales. The number of shorted shares has risen sharply since mid-April in such Dow-index stocks as American Express, General Motors and GE.

The total number of shorted shares of New York Stock Exchange-listed companies rose to a record 17.65 billion shares as of June 13 from 16.43 billion as of May 30, a 7.4% jump in just two weeks. Clearly, the bears are running wild.

Holland, an optimist, points out that heavy short-selling can be a bullish sign. If the market turns up the shorts could suddenly be in the red with their trades, and could rush in to cover them. Their buying could add fuel to any rally.

He thinks the market sell-off has entered ‘the throw-up stage,’ and once in that stage, he says, ‘beware being short!’

But I pointed out to Holland that, although there was some short covering in late March as the market rebounded, the total of NYSE shorted shares didn’t decline much. And by mid-April it was rising again.

That shows there are some very bearish -- and determined -- short sellers out there. Scaring them out of their positions may not be easy.