Short Selling Getting Center Stage

June 21, 2008 at 12:13 am

The practice of short selling and spreading rumors in order to boost better returns and the effects caused by invisible short sellers is in the media more and more often in recent months. It has become almost a fixture on the pages of Financial Times, for example.

Back in March 2008 it was the banking sector. It was front page news in financial publications and even made it through to mainstream news on the BBC. The banking sector was badly hit by a sharp decline in share price, followed by fluctuations that seemed to have gotten out of control (and which were explained with the moves of short sellers). The sell off was attributed to a panic created artificially by short sellers who reportedly spread rumors about an impending crisis at certain banks, which made the share price plunge down. The short sellers (and, alongside, all those watching the markets closely) then picked up shares in the companies they had ruined on the cheap (there was frantic buying into the same banks just a few days afterwards, just about the time that the short sellers would have committed to buy). It was reported that the practice was to be investigated by the FSA (which is still on the case, as more and more instances of massive short selling moves keep coming about).

More recently, in June 2008, similar fluctuations occurred with the housebuilding companies in Britain. A 13 June 2008 article entitled Wild Fluctuations at Housebuilders in the FT opens with the observation:

Speculators, short-sellers and market rumours were held responsible for wild swings in housebuilders’ share prices on Thursday, with Barratt Developments gaining ground for only the second time in four weeks.

The swings were so hectic, that dealing into shares (which moved 50 points up and down within a single day) was even suspended for a short while, so that the computing systems could cope with the amount of trades going through. The article is illustrated with an extraordinarily choppy chart of the intra-day movements in Barratt’s (BDEV) price on June 12th, showing such drastically swinging movements that the chart could be used as a teaching tool for day traders.

“This isn’t a case of fund managers suddenly liking the stock,” according to Will Duff Gordon of Data Explorers, which monitors short-selling interests. “The moves come from short-sellers taking profits while they can.”

The ‘short sellers’ are invisible. Even though the people who attribute the problems of various banking or building companies stock to the behind-the-scenes activities of short sellers, do not name names — rather, the say, it is known who the ‘culprits’ are. The interesting issue is that lately the short selling theme is taking the shape of a morality discourse, and there will be more to come as the tendency seems to be toward making it morally unacceptable. Morality, however, does not have a straightforward place in the rational world of finance, so they want measures that would regulate and probably even outlaw it.

Short selling is usually the domain of those in the know. Ordinary novices like myself still stick to the idea that in order to sell something, you would need to have bought it first. Not so, apparently, as when you ‘short’ you do not need to owe what you sell, and you do not even need to put up the money for this virual transaction until a later point in time when you need to ‘buy’ what you have ‘shorted’. A very different concept from the one of prudent buying low and selling high. It is more about boldness and daring speculation, as we learn from the interesting chatty City Slickers: Make a Million from the Declining Market by Anil Bhoyrul. This cheaply published paperback is not a book that will make you a significantly better investor, it is not analytical enough. But it is an interesting glimpse into the reality of short-sellers, into the daily life of the City, and into the behavior of day traders. And these are things that are worth knowing more about, especially as for people like myself, in the absence of the ‘mastermind circle’ recommended by Andrew Carnegie and Napoleon Hill, investing is a lonely pursuit. Mr. Market, in Benjamin Graham’s terms, may be the temperamental guy whose mood swings we never come to fully understand or predict. Not so, however, when one reads Bhoyrul’s book: helps to get to know at least one of Mr. Market’s aspects — the logic of the ‘moods’ related to short-selling frenzy.

© Dina Iordanova
21 June 2008

One Up On Wall Street by Peter Lynch

May 17, 2008 at 2:58 am

I postponed reading One Up On Wall Street: How To Use What You Already Know To Make Money In The Market for quite a while, mostly because I thought that being published in 1989 (which is nearly twenty years ago) it would barely be of much relevance today. What a mistake. If not timeless, the book is indeed a classical introduction to understanding how the stock market works and it is as insightful today as it was back then, a must read for investing novices.

First of all, it indeed gives insights as to how to use the things that you already know to get to understand and pick stocks. Secondly, it dismisses a number of widely shared prejudices and tackles head on the mistakes that amateur investors make not only in discovering companies and buying stock, but also in the process of running a portfolio, so it certainly helps a lot with getting more confident in believing in yourself in picking ‘winners’ and his famous ‘tenbaggers‘. Lynch is sort of condescending on the importance of technical analysis and strictly prefers fundamentals.

The two most important features of his approach, however, are that he categorizes the companies (and insists to approach the respective categories of stock differently) and that he gives much attention to the way the company maintains a narrative about itself.

The typology of companies includes six categories: Slow Growers, Stalwarts, Fast Growers, Cyclicals, Turnarounds, and Asset Plays. If one manages to assess today’s companies according to his classification, one can learn a lot about making the right choices.

In analyzing the behavior of companies Lynch does not stop at discovering and picking the stock, as most other investment books, but also traces what happens afterwards. I found the part of the book which discusses when to sell and what signs to look for in different types of stock in making this decision, of most interest. Here is what he says, for example, on the issue of when to sell a Fast Grower.

You could have sold Holiday Inn when it hit 40 times earnings and been confident that the party was over there, and you were right. When you saw a Holiday Inn franchise every twenty miles along every major U.S. highway, and then you traveled to Gibraltar and saw a Holiday Inn at the base of the rock, it had to be time to worry. Where else could they expand? Mars?

I admit it was this discussion that opened my eyes about Starbucks (SBUX): I had wondered if it was about time to sell off, and it helped me decide.

As a humanitarian who likes stories, however, I found Lynch’s insistence on checking the company’s ‘story’ most compelling. Throughout the book he has reproduced copies of the performance charts of some of the 1400 stocks he has owned over the years, with his observation comments on the behavior of the stock written all over. He maintains that a company adjusts its story to suit the performance as reflected in the numbers. What he recommends is ‘checking the story’ — first of all comparing if the claims correspond to the figures (and he gives you tips of giveaway signs of discrepancies between story and numbers) and then keeping on checking on a regular basis, to see if the story remains consistent and if it still corresponds to what you see on the balance and asset sheets. I loved that.

© Dina Iordanova
17 May 2008

Portfolio Grader: Navellier

May 4, 2008 at 11:22 pm

Louis Navellier’s The Little Book That Makes You Rich: A Proven Market Beating Formula for Growth Investing, endorsed by Steve Forbes, struck me as a really helpful and insightful guide to the principles of growth investing. It gave me a much better understanding of some of the underlying principles of stock picking and portfolio management. Ultimately, however, the book reads as one extended advertisement for the services available from Navellier’s company, which publishes four investing advice newsletters, the subscription to each costs about $1000 per annum. There is a web-site, Get Rich With Growth, that has been created for the readers of the book, which is now free (but not clear for how long).

The site contains a Portfolio Grader that allows you to enter the codes of stock you are considering buying. Once you do this, it rates the stock against the eight main categories which Navellier uses for assessment, and gives it a fundamental and a quantitative grade (fundamental grade is weigthed at 70% and the quantitative grade – at 30%), as well as an overall grade which translates into a recommendation, A- Strong Buy to F – Strong Sell. The site also rates your overall portfolio, from A to F.

I worked to create a tentative portfolio for myself, aiming to get an overall grade of an A for all the stocks I am planning to invest in. But I also did something else: I went to the Stockpickr web-site which lists the content of various people’s portfolios (probably with some delay in time but a very interesting reading nonetheless). I got all the stock codes for what was listed as the contents of Navellier’s portfolio and entered them into the Portfolio Grader on his own site. The surprising thing was that of the 30 or so stocks only a handful came out as A-rated in Navellier’s own system. Quite a few had fundamental grades of B and quantitative grades of C, and the overall grade for the portfolio itself was a B. Surprising, indeed, provided this man is a growth investor — why would he invest in a confirguation that does not seem, in his own ratings, to be geared to supply the best results? Especially as he writes in the book that if a stock falls below fundamental grade of A or below a quantitative grade of B it is immediately sold (p. 125). True, he is discussing the so-called ‘quantum’ stocks in this part, those of aggressive growth potential; he may not be interested to have many of these in his portfolio during the currently volatile period. Still, I feel there is a contradiction here.