The Three Bears Plead Their Case to Fund Managers
Las Vegas oddsmakers wouldn’t have placed very good numbers on this matchup in Newport Beach this week: With the Dow Jones average near record highs, three stock market bears go before 130-some pension fund managers to plead their case.
It didn’t go well at all. But if you put any credence in the idea that the majority view of the market is often dead wrong, the poor reception for the bears could be a flashing red light.
The fund managers, meeting in Newport Beach for an investment conference sponsored by pension adviser Collins Associates, were hardly in the mood to hear why stock prices are too high. And why should they be? Many are having one of their best years ever, with stock prices generally up 20% to 40% so far.
The bears, of course, are having one of their worst years. And the three who sat on a panel at the Collins show are among the most notorious of bears: They are “short sellers,” who target stocks that they believe are likely to plunge. The “shorts” borrow shares and sell them in the open market, expecting to repurchase them later at a lower price and thus profit from the spread.
This year, those lower prices have never come for many stocks. Prices have zoomed to one record after another. If you short a stock at say, $20, and it soars to $30, you’re out $10. For the three bears at the Collins show--Joe Feshbach of the Feshbach Bros. firm in Palo Alto, Jim Chanos of Kynikos Associates in New York, and Russ Faucett of Barrington Partners in Los Angeles--those kinds of numbers have been absolute murder on their short portfolios.
Chanos estimated that most short sellers have lost 30% of their capital this year. If it was just their own money, that would be one thing. But this is capital that big investors have entrusted with the shorts, believing that it’s worth betting on a money manager whose specialty is identifying overpriced stocks. After all, stocks go down as well as up. Why not play both ways?
Even this year, with the market overall soaring, there have been plenty of individual stock disasters. So why, the pension managers wanted to know, have the shorts done so poorly? The obvious answer seemed to be that the shorts are simply targeting the wrong stocks.
Joe Feshbach doesn’t believe so. After eight years of successful shorting, he said he can’t believe that the rules have changed regarding what makes an overpriced stock. Bad management, one-product flashes in the pan, financial fraud--Feshbach said he and his brothers still find all of these things out there, and they short the companies accordingly.
What he can’t understand, he admits, is why investors continue to clamor for such stocks, driving prices even higher. “This is like ‘Nightmare on Elm Street’ for us,” he said. “A Ouija board would have done us a lot more good this year” than fundamental analysis.
In part, the shorts’ problems have been compounded by what they allege are “short squeezes”: Feshbach and others say some big mutual fund managers are trying to drive the shorts out of business by deliberately buying up the stocks they target, out of spite.
Still, Feshbach said, he believes that the shorts’ poor performance mostly just reflects the high level of speculation in the market. “I think there’s a lot of thoughtless investing going on--I hope,” he said.
Chanos insists that it’s only a matter of time before the fundamentals win out, vindicating him and his cohorts. “This is, in our opinion, the ultimate inefficient market now,” Chanos said, because the shorts have been so disgraced that no one wants to give them new money.
Indeed, when panel moderator Budge Collins asked the 130-some pension managers how many expect to put up new money for short-selling strategies over the next five years, a mere six raised their hands.
(Worse, rumors persist--though Chanos and Feshbach denied them--that many of their remaining clients will leave them by year’s end, forcing them to close up shop.)
There was no Collins conference last year at this time. But if there had been, probably many more hands would have gone up. At this point last year, the Feshbach brothers and Chanos were among the most glorified money managers in the country, because they were short in the midst of the first major bear market since 1982. Everybody wanted to be a short seller in October, 1990--just as the stock market was bottoming.
If the incredible affection for the shorts a year ago was a clear signal that the bear market was over, then the reviling of this group today could be an equally powerful sign that wildly overpriced stocks’ days are numbered.
How NOT to Pick Stocks
You don’t have to be a short-seller to appreciate their work. The same telltale signs of trouble that make a company a good short-sale candidate should encourage fundamental investors to simply stay away from the stock, short-seller Jim Chanos says:
* Consumer Fads: These are firms whose products or concepts are one-time in nature, such as Cabbage Patch dolls in the mid-’80s. “Wall Street always extrapolates and calls something a growth industry,” when in fact it may be a mere fad, Chanos says.
* Accounting Frauds: If a company reports great earnings but its cash flow is negative, or if it books possible future income as current earnings, something is wrong. “There are lots of companies that not only skirt the line (on fraud) but jump over it,” Chanos says.
* Technological Obsolescence: New technology is great--except for the companies it replaces. When a new product hits the market, “Look for what it renders obsolete,” Chanos says, and short or avoid those firms.
* Booms That Go Bust: Houston in ‘85, Boston in ‘90, L.A. in ‘92? A sign of a bust in the making is when the price of something has been wildly inflated by easy credit, Chanos says. But he also warns that booms can reinflate a few times before the final bust.
