It’s one thing when some online commenter yells “fire” in the crowded stock market theater, expecting investors to jump ship and dump their investments before the “Crash of a Lifetime.” It’s another when multi-billionaires who made their fortunes from speculation take huge bearish bets in the market.
The billionaires are positioning themselves for a big butt kicking in the market.
One after the other, they are lining up their investment strategy for negative stock returns ahead. George Soros, who famously made $1 billion in a day shorting the British Pound, has made a massive short bet in the S&P 500.
Carl Icahn also made a huge bearish shift in his portfolio. According to Barron’s,he was 149% short at the end of the first quarter compared with 25% at the end of 2015 and 4% net-long a year ago.
Are these Wall Street legends making the right call? In my own opinion, the odds favor lower stock returns ahead. Much lower.
First, we are in the midst of one of the longest bull markets ever. Whenever there’s a little scare, a magical wave of buying comes into the market to prop up stock prices. Even the worst start to a year ever couldn’t stop stock prices from advancing in 2016. But, that is not sustainable.
Not only is this bull market long in the tooth, but valuations are also in nosebleed territory. The median / price sales ratio on the S&P 500 is at its highest ever. There is nowhere to hide.
How can I learn to short stocks?So if you want to ride Soros’ and Icahn’s coattails, what can you do?
Well, there are a few ways to short the stock market. You can bet on a fall by buying put options. Of course, your timing might have to be impeccable in order to cash in on your bearish bet. There’s nothing worse than being right but having the wrong timing.
You can also get against an index like the S&P 500. In general, I think inverse funds are bad bets. For one, when you short the S&P 500 you are shorting companies like Apple [Nasdaq: AAPL] and General Electric [NYSE: GE].
Even worse are levered inverse funds that re-set their portfolio daily. The higher volatility of bear markets tends to chop up these funds over time. So, it’s possible that the market could fall 20% but you still lose money owning a levered inverse fund. Your outcome depends to a large extent on the progression of daily returns in the stock market. No one can predict that.
The largest companies in the U.S. market dominate the S&P 500 index. Why would you short the world beaters? Sure, they may go down, but will they go down as much as a third-tier company operating in one market that just saw its largest customer go bankrupt? Probably not.
That’s why, at Forensic Investor, we prefer to short individual companies. Companies that have aggressive accounting where management is pulling the wool over investors’ eyes and artificially propping up their stock price can lead to solid returns, even in a bull market.
But, in a bear market where there’s real selling and real blood in the streets, investors tend to sell these low-quality stocks first and ask questions later. That can lead to outsized returns from the Dark Side.
Sometimes we will short an entire sector, like technology, where the entire space may be exposed to low earnings quality. But, the real juice in a bear market comes from individual stocks imploding.
While the S&P 500 was cratering in 2008 there were many stocks falling 2x-2.5x what the market was doing.