It was late 2008. There was a long and growing list of pundits who claimed they predicted the catastrophe, but a far shorter list of people who actually did. Of those, even fewer had the nerve to bet on their vision. It’s not easy to stand apart from mass hysteria—to believe that most of what’s in the financial news is wrong or distorted, to believe that most important financial people are either lying or deluded—without actually being insane.
– Michael Lewis, The Big Short
It’s time once again for the Advisor Roundtable! Back in March, I wrote about the investment banking psychopaths whose limitless greed and indifference to the public consequences of their actions caused the worst financial collapse since the Great Depression.
But an equally fascinating story of the crisis comes from a completely different angle: the investors who shorted subprime mortgages before anyone else, making billions in the process. What personal characteristics make a great short-seller? As the above quotation from Michael Lewis suggests, successful shorting requires a contrarian streak and self-confidence to go against the crowd.
I can’t think of any people who better reflect these characteristics than KCI’s investment experts. Although these profit paragons focus their investment services on the best investments to go long (exception: Stocks on the Run, which recommends both longs and shorts), they also have ideas of what securities to short – or at least avoid. After all, distinguishing between good and bad investments is the key to beating the market, something our experts have an uncanny ability to do on a regular basis.
Still, for many investors, shorting is not necessary. The market goes up twice as often as it goes down and long-term wealth comes from the long side. Shorting often risks short squeezes, margin calls, and unexpected takeovers that can cause struggling stocks to jump. But, as the financial crisis of 2008 proved, shorting can sometimes be extremely profitable if you can time it perfectly. Even if you choose not to short, knowing what smart and risk-tolerant investors are shorting can steer you away from going long bad investments. A large part of successful investing is avoiding mistakes.
So, let’s get on with it. Specifically, I asked the following question to the investment experts:
What is your favorite idea to short – or at least avoid — for the rest of 2010?
The answers were, as usual, well thought out, varied, and provocative. Read on to find out the details:
Roger Conrad — Utility Forecaster, Canadian Edge, MLP Profits
With European sovereign debt challenges receding, income investors are once again losing their fear of chasing high yields in places where they shouldn’t. One area I’m particularly wary of is closed-end funds. Investors buy these as they would stocks on major exchanges and some of the posted yields are massive. But unlike stocks, what’s paying that yield is often a mystery. Most funds pay mainly from investment income. But others rely heavily on leverage or cash on hand. Gabelli Utility Trust (NYSE: GUT), for example, yields more than 9 percent now. Buy only nine cents per dollar of dividends is from investment income. That can only be sustained for so long. Moreover, Gabelli Utility Trust also trades at nearly a 60 percent premium to the value of its assets. The stocks in the portfolio are good. But you only get 63 cents of stocks for every dollar you spend on the shares. Those are two good reasons to dodge Gabelli, as well as to check out any closed-end fund’s internal workings before you buy.
Elliott Gue — Personal Finance, Energy Strategist, MLP Profits, Stocks on the Run
Yiannis and I recently recommended a short in a prominent solar power company in our $5 per month advisory, Stocks on the Run. Solar power is an extremely expensive source of power and completely impractical as it’s extremely difficult to integrate solar with the existing electricity transmission network. But, there’s a shorter term catalyst as well: declining government subsidies. Without subsidies, solar makes no economic sense whatsoever; heavy subsidies in countries like Germany, Italy, Spain and Greece are behind growth in solar power companies over the past few years.
Germany’s subsidies were cut as of July 1 and further cuts are likely in 2011. Spain, Italy and Greece were all big growth markets for solar over the past few years but all are now focused on fiscal austerity and cutting deficits — they can no longer afford profligate spending on an expensive power source. In the U.S., cap and trade is now officially dead, removing another potential source of growth for the group. While a U.S. energy bill is likely at some point and will contain further solar subsidies, the U.S. alone can’t sustain the industry’s growth rate. The solar industry faces a glut of capacity in 2011 and with subsidies declining, I am looking for results to deteriorate over the next few quarters.
Yiannis Mostrous — Silk Road Investor, Global ETF Profits, Stocks on the Run
CurrencyShares Australian Dollar Trust (NYSE: FXA) should be avoided by investors for the rest of the year, and should be shorted by investors that are long emerging markets — especially China.
The Australian economy has performed well because of Chinese demand for commodities and especially the latter’s strong bounce in early 2009. This was enough to boost Australian exports and helped support consumer spending because so many Australians work in the mining industry. The economy bounced back so quickly that the Reserve Bank of Australia was the first central bank in the developed world to start hiking interest rates.
It is the view here then that if China disappoints the Australian currency will be hit the hardest. Furthermore, the Australian dollar has recently rallied close to its 2008 high instead of looking to trade closer to it longer-term value.
The latter should be a more appropriate move as the Australian household has not been very prudent with its finances, something that should eventually negatively affect its currency. So, household debt to disposable income is close to the all time high they hit in early 2008 which was 156 percent. Furthermore, the majority of mortgage loans in Australia are variable in nature so higher rates will not be helping.
David Dittman – Canadian Edge
The bland economic data in the appropriately titled Beige Book tells me that the third quarter, at least, could be a tough one for consumers and, by extension, consumer discretionary stocks, including retailers. The Beige Book, a compilation of reports from the 12 U.S. Federal Reserve districts, included observations such as “consumers continue to deleverage and correspondingly remain price sensitive” in Dallas, “retailers reported maintaining relatively low inventories amid dampened optimism for the back-to-school shopping season” in Chicago, and “the consumer is still cautious and looking for value” in Philadelphia. The third quarter could prove a season of downward revisions to guidance for U.S. retailers.
Consequently, I would avoid the Consumer Discretionary Select SPDR (NYSE: XLY) and the SPDR S&P Retail (NYSE: XRT).
On the other hand — or the other side of the border, if you will — you have a consumer discretionary like Cineplex Galaxy Income Fund (Toronto: CGX-UN.TO) (Other OTC: CPXGF.PK), which we recently added to the Canadian Edge Conservative Holdings. Cineplex is the dominant movie-theater operator in Canada, with more than 1,000 screens using the latest, greatest display technology. Cineplex Galaxy stayed strong during the downturn, as a trip to the movies for a family of four is a bargain compared to a ballgame, for example, even during the worst recession in decades. And in any case Canada’s consumers are in fine shape due to a relatively healthy employment situation.
On top of all that, Cineplex Galaxy will convert to a corporation ahead of 2011 taxation without cutting its monthly distribution.
Jim Fink – InvestingDaily.com
I’ll guarantee success by mentioning three penny stocks that are worthless: Motors Liquidation (Other OTC: MTLQQ.PK), Fannie Mae (OTC BB: FNMA.OB), and Freddie Mac (OTC BB: FMCC.OB). But these are too easy. Plus, all three stocks are impossible to borrow for shorting.
I’m going to go out on a limb and recommend shorting a momentum favorite, but isn’t that the contrarian streak needed to make big bucks? Specifically, I don’t like Netflix (NasdaqGS: NFLX), the movie rental company. The stock has skyrocketed more than 500% over the past 18 months with strong growth and customer delight over its digital streaming “Watch Instantly” service.
But the great times appear to be ending. On July 21st, the company reported second-quarter revenues below analyst estimates; the stock plunged more than 13% the following day. It appears that new and existing Netflix customers are choosing the lowest-priced subscription plan as a means to get access to the free video streaming service. I’ve never liked a business model based on “free.”
When a stock is priced for perfection as Netflix is, any disappointment will be devastating to the stock price. Competition is increasing with Coinstar’s (NasdaqGS: CSTR) video kiosks offering DVD movies for a buck each and Wal-Mart’s (NYSE: WMT) Vudu offering high-definition video on demand. Oh, and don’t forget Hulu.com.
I might be willing to overlook these negatives if Netflix insiders were showing confidence by purchasing the stock, but they are selling it in droves. Netflix shares are easy to borrow for shorting. Personally, my preferred method for expressing a bearish view on a stock is buying put option spreads or selling call option spreads. Options limit your risk to the price you pay, unlike shorting which risks margin calls.
I see the stock falling to $70 or lower sometime within the next year.
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