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Short Selling Stocks – There is Nothing Evil About Shorting!


Most investors run into serious trouble when they confuse strategy and tactics. Trading around positions is tactical; strategy is where your long-term goals are. We have had a bull market in natural resources and BRIC markets since most developed stock markets topped out in 1999. There is no problem with the strategy to invest in the markets that offer the highest organic economic growth — growth that is driven by savings and investment, rather than constant borrowing.

In 2008, the BRIC markets did not come down because they have issues with economic growth, but because the Western financial system tried to self-destruct. While the long-term is certainly bright for many emerging markets, they are smaller overall and developed markets have to ability to hand them big headaches. When developed markets come down, they bring down the much healthier emerging markets. This is why playing defense in the current environment is so important.

A case in point is my favorite natural resource-driven market, Brazil. The Brazilian index was doing fine before U.S. banks, as represented by the Financial SPDR (NYSE: XLF), began to fail. The correct tactical trade in 2008 was to lighten up on emerging market assets — despite their bright future — raise Treasury bond and gold bullion allocations, and sell short the financials that were dragging the Brazilian and other BRIC markets down.

Some investors don’t like short selling as there is unlimited downside and only 100% upside — this is pure baloney. With derivatives like options, futures and credit default swaps, short selling in weak companies or indexes has multifold upside. I do not believe that CDS trading is to blame for the de facto failure of AIG (NYSE: AIG) or the bankruptcy of Lehman. This is a failure of regulators and central bankers to reign in the multi-country credit bubbles that the Western financial system is still operating on.

Short-selling is as legitimate of a stance as going long and it helps you with an absolute return portfolio. You do the work on a stock or sector, you find out that it is overvalued, you wait for the catalyst that lets the market begin to realize and discount your investment thesis, and you pull the trigger. Uneducated investors deride short-sellers as “evil” as they make money as those very same uneducated investors lose money. That is a silly way to look at the matter. If someone is smarter than you or me at the art of investing, you and I should learn from that individual, not hate him, right?

Uh … Right?

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