October 15, 2014 / 5:08 AM / 3 years ago

U.S. stocks slide allows short sellers to smile again

Traders work on the floor after ringing the opening bell at the New York Stock Exchange, October 14, 2014.Eduardo Munoz

BOSTON (Reuters) - The stock market's long-suffering short sellers finally have something to smile about.

    Investors who make a living betting that stock prices will fall are in a position to profit handsomely as the U.S. equity market sinks, with its biggest weekly plunge in more than two years last week and continuing to decline so far this week.

    After lean years in which short-biased funds tracked by eVestment have posted double-digit losses every year since 2008, some were able to post among the investment industry's best returns in September and may well have done even better in the first two weeks of October.

    "Short-selling is the worst way to make money but recently I've had a change of heart and I think there are enough valuation obscenities to create an opportunity," said prominent bear William Fleckenstein, who shuttered his short-only fund in 2009, but continues to invest money through another portfolio. "It felt like putting on an old, comfortable leather jacket."

    The short funds - who borrow shares and then sell them in hope of buying them back at a lower price - are hopeful that the bull market that has lasted more than 2,000 days, and has not experienced a 10 percent correction in three years, may be coming to an end.

    And that's potentially bad news for names that shorts have had in their crosshairs for ages - the likes of electric car company Tesla Motors Inc (TSLA.O) or online video company Netflix (NFLX.O) - stocks some investors see as overvalued.

    Equity markets now look vulnerable, thanks to the winding back of U.S. Federal Reserve easy money policies, concerns about weak global economic growth, a plunge in the oil price, and fears about the spread of the Ebola virus.

    Fleckenstein, who along with other notable short sellers, such as Jim Chanos, Doug Kass, and David Tice, built a reputation for successfully betting against companies that crumbled, said he put on aggressive short positions recently for the first time in five years.

    Kerrisdale Capital's Sahm Adrangi, who presented his long-researched short bet against Globalstar Inc (GSAT.A) last week and sent the satellite communications company's stock price tumbling 42 percent, said it was easier to get others in the market to listen to short selling ideas when the whole market was sliding.

    "When short sellers play a more activist role there are times when markets just shrug it off but then there are times like now when people pay more attention," he said.

    He has also shorted Tesla, which has fallen 17 percent in the last month, and personal camera maker GoPro (GPRO.O) which has tumbled 20 percent in the past five days.

    

    REBOUND IN SEPTEMBER   

    Short-biased mutual funds tracked by Lipper climbed 7.13 percent in September while hedge funds that focus exclusively on selling stocks short inched up 1 percent last month, Hedge Fund Research data show. Some hedge funds fared more poorly than mutual funds because the hedge funds were not fully invested, analysts said.

    Most other funds, be they stock mutual funds or hedge funds, were knocked lower in the last few weeks as the Standard & Poor's 500 index has plunged about 7 percent in less than a month.

    For example, Robert Citrone's Discovery Global Macro hedge fund was off nearly 3 percent in the first week of October, an investor in the private fund said. Claren Road, the hedge fund owned by private equity giant Carlyle Group, lost roughly 5 percent in the first week of October, hurt by its bet on housing finance companies Fannie Mae FNMA.OB and Freddie Mac FMCC.OB, added an investor.

    "If you were just outright short almost anything during the past week, you've done well," said Nicholas Young, a portfolio manager at Conventus Capital, "But many hedge funds are long some names and short others with their net market exposure near neutral," he added.

    One popular short position among hedge funds is General Motors (GM.N), according to Goldman Sachs. The company has been plagued by vehicle recalls after a number of deaths were linked to faulty ignition switches, and shares are down 27 percent on the year.

Kass, who runs hedge fund Seabreeze Partners Management, is shorting GM and rival Ford Motor Co (F.N), whose shares have slipped 12.2 percent in 2014 even as auto sales figures have been strong. Kass said he has been increasing his auto industry shorts because of the deterioration of the European car market coupled with his view that U.S. auto production is reaching a peak.

    Blue chips like General Electric Co (GE.N), which has been building its oil and gas equipment and services arm, and oil major Exxon Mobil Corp (XOM.N), are also among names that some hedge funds are betting against. Those names tend not to fit a short-seller's profile, but they've worked - both have posted double-digit losses in 2014. The recent slump in oil prices has hurt their shares.

    Names investors associate with big short bets like Tesla and Netflix have only recently suffered reversals. Netflix is still up 22 percent on the year, and Tesla has gained 51 percent so far in 2014 – though it is down nearly 20 percent in the last month.

    With prominent investors bracing for the selling to continue, additional evidence of weakness in the European economy, the widening of the Ebola outbreak or more declines in oil prices, could further sap buying interest.

    Whether another dose of gloom will benefit so-called short-sellers by triggering new asset flows remains to be seen.

    Among the world's roughly 10,000 hedge funds, there are only about two dozen dedicated short sellers and most are small with the entire group overseeing only about $2.8 billion in assets, a small fraction of the hedge fund industry's $3 trillion.

    Among the short-focused mutual funds is the $450 million Federated Prudent Bear Fund BEARX, which gained 6.33 percent in the last month and Leuthold Weeden Capital Management's $81 million Grizzly Short Fund GRZZX which climbed 11.42 percent in the last month.

    These funds, which have a history of taking in fresh money during tough times, have already seen $250 million in new inflows between April and the end of August, said eVestment's head of research Peter Laurelli.

    Other hedge funds, which can hold significant short positions, also adopted a more cautious stance. Net long positions, for example, were cut to 48 percent at the end of August from 58 percent in December 2013, eVestment data shows. Credit Suisse data shows funds have sharply reduced their long exposure as the market has slumped.

with additional reporting by Jennifer Ablan and David Gaffen; Editing by Martin Howell

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