Making Short of the Short Sellers

Within mere days of the Security and Exchange Commission's announcement of a tough new rule designed to limit "short selling" (now believed responsible for driving share prices of financial stocks into the tank) you can see and hear the howls of protest erupting from every quarter (e.g. 'SEC Short-Sale Rule Gets Negative Reviews', The Wall Street Journal, July 19, p. B1).

What is short selling, also called "shorting"? This occurs when financial (especially) share sellers aim to profit from share declines by selling borrowed shares then buying them back in the market at a lower price. In a more egregious variation, called a "naked short sell", the shares are sold without any arrangement to have borrowed them first. The end result? These shorting operators make a killing with little or no risk, and certainly none of the upfront exposure that normal purchasers of shares have. (So, in many respects they are like the oil commodity speculators who only have to produce 5% of the total purchase to speculate a much higher price). Prior to the SEC rule, by one report, it was estimate short sellers had creamed $11 billion of profits from their short sales.

What is amazing to me, especially in view of the much reported market timing ploys of a few years ago, is how many average Joes and Janes still entrust their hard earned money to Maul Street. This, despite all the recent markers that disclose it is a bad bet.

The cold, brutal and hard fact of the matter is that most Americans (unless they have at least $2-3 million in disposable wealth) had best stay out of the Maul Street casino. It is purely a game for the 'whales' (as huge bettors are called in Vegas). Even mutuals offer little or no assurance of getting anything more than chump change - unless you are remarkably lucky in your redemptions.

A Stanford University study- based on the median return of 62 mutual funds- showed that $1 invested in 1962 would have grown to $21.89 by 1992, on a pre-tax basis. The study disclosed that the $1 would have grown to only $9.87 on an after-tax basis. And the investor would have had to come up with $12.02 to pay the taxes. By contrast the study showed that a “conservative” investor who put assets into a U.S. Savings Bond in 1962, had every $1 become $10.93 by 1992.

It is easy to work out from these numbers which investor actually fared better over the thirty-year interval according to the study. Hint- hint: it wasn't the sucker in stocks. Unless mutuals investors do the math and watch the numbers they cannot be aware of how little they're actually taking home. (A point also made emphatically in The Wall Street Journal, Nov. 27, 2003, page D1, 'A Harsh Truth: Most of Your Investments Won't Make Money- Even in the Long Term', after assessing stocks, bonds and mutuals).

Recent articles appearing in MONEY magazine, and The Wall Street Journal bear this out, noting that in the past ten years the S&P 500 has barely eked out 1.6% a year, not even matching the gains of CDs or Treasuries. Plus, one has to contend with onerous expenses, fees )e.g. 12b-1) clobbering from every angle.

It is also well for small investors to understand that, to a large degree, they are in a game with a 'stacked deck'. Not only that, but under current laws their investments are almost entirely blind. Like buying a pig in a poke. This point was emphasized in a London Financial Times article (‘A Metaphorical Proposal’, Mar. 13, 2003, p. 11A) by Michael Skapinker. He cited remarks by Joseph Berardino – chief exec of Arthur Andersen- who noted how the current reporting system “fails to communicate essential information about the real risks facing companies” to the small investor.

The basic Wall Street pyramid game is elementary to grasp. Pundits, wags and paid flacks on cable business channels hype the various stocks, funds or instigate a "buzz" about them - to get suckers to buy in. The increasing buy-in inflates the price-to -earnings ratio (P-E ratio) and produces a bubble of high profits. The "Big boys" (mostly large, institutional investors, but also big money single investors) get tipped 1-2 days in advance and cash out, leaving the little guys to sink. If they're lucky they may earn a few bucks. Not much.

For example in the Financial Section of the Balt. Sun of 1/27/97, p.1C there was this little headline: INVESTORS COMPLAIN OF UNEVEN EXPOSURE :

Quote:
General Motors Corp. gave a welcome warning last month to a few close friends. One by one, the automaker called analysts at top brokerage firms on Dec. 18 to say that fourth quarter costs would be higher than expected. Word was quickly passed to those (brokerage) firms' big clients, whose sales of GM stock sent the shares tumbling $1.375 on a day when the Dow Jones Industrial Average rose 38 points. Other investors had to wait until the next day - when nine analysts cut fourth quarter earnings estimates - to find out what GM said in private.

The thievery works eventually because most manjacks are conditioned to "buy and hold" rather than fold when the share price dives below a certain threshold. (Which ought to be the tip off). Thus, there are always ample marks left at the end game to be properly fleeced. Amazingly, they're always ready to play the game again, and pile their newly saved up money in.

I wised up in 1997 after the DOW was "juiced" and reading a lot of books and article on how the game was played, especially the psychological enticements to become "an investor". (I.e. you were "missing out" if you didn't plunk that cash into the Street). I cashed out of all the high risk equity and other funds before the 2000 bubble burst. I've stayed strictly with money market accounts, funds, and laddered CDs since. I did lose more than I'd like to have in a few bond funds, but also pulled out of all those in early 2000. (That was after I learned of the collateralized mortgage obligations or "toxic waste" piled into many of them)

Slow and steady is the way to go, albeit not "sexy" - and anyone who tells you any differently is trying to pick you off. I may not have millions at the end of the day, but won't have to go back to work prematurely because an IRA tanked by 40% or 50% - as many too trusting people are learning now.

The only real diversification in the end, is not to keep all the eggs in Maul Street's casino coffers. As Joe Dominguez and Vicki Robin note in Your Money or Your Life, about 20% on the Street is perhaps the maximum, the rest in cash (money market) accounts, laddered CDs and Treasuries. That way - when the market tanks by 40-50% as it surely will when the next bubble bursts, you don't have to commence from square (X- 100) again. Particularly as all losses are compounded in a downmarket environment - since as I noted- Maul street will still exact its Shylock cut (in expenses, fees, commissions etc) even as you're reaping market losses! Add a 15% loss to a 5% load, and more than 3.5% in fees-expenses and the results are not very pretty.

However, the hype and media fomenting of the PR of the market mythology keeps most prospective retirees thinking that they must be in the market or they won't be able to retire. Even now, the media drumbeat has begun for people – with portfolios and 401ks still in tatters- to get back into the market game. “Buying opportunity” is the mantra issued to rope in millions more suckers. Meaanwhile, oldsters who've taken a beating in the current Bear market may be looking at another ten to twelve years of work to make up their losses - assuming they can find work!

The stock market's sole purpose, As E. Brockway observes in his The End of Economic Man, 1990, is to steal capital from the poor or middle class (that can least afford losses) and give it to the rich. The means to achieve this are not obvious, but all one needs to do really is pay attention to the financial news and especially how market manipulation rears its ugly head again and again.

One day, perhaps, people will learn how to protect their assets themselves, without being drumbeaten into being hostage to stock sharks, con artists, shorters, speculators and other denizens!