The Bursting of the Short Bubble

The Dow Jones Industrial Average will reach 3,000,000. That's my official forecast for November 2108. My calculation, by the way, assumes stocks replicate the growth achieved over the last century. Given the pace of technological innovation, plus the potential for worldwide growth, it's possible we'll get to 3,000,000 a year or two early. So, stand by. We'll have to wait and see.

Here's another forecast: If you're going to do a lot of shorting between now and 2108, you're going to lose a lot of money. It's an easy forecast to make. That's because business is, in the aggregate, always profitable. The accumulation and compounding of those profits, over time, makes higher stock prices a certainty. And that, in turn, makes short-sellers certain losers.

The best environment for shorting occurs when the markets are punch-drunk with enthusiasm, and few investors are interested in shorting. That's when a handful of shrewd short-sellers can move in and pick off a nice return.

Today, though, the landscape is exactly the opposite. Pessimism is at record highs. Stock prices have already been crushed. And short-interest has swollen to unsustainably high levels -- multiplying several times over in a few short years. Add it up, and we have all of the ingredients required to bring out the dreaded "B" word: bubble. Take a look at this chart below from bespokeinvest.com.

NYSE Short Interest, 2000-08

Click here for larger image.

Source: bespokeinvest.com

Buyers of stock risk only the amount of their investment. Not so for short-sellers. Buzz Lightyear's (Toy Story) proclamation aptly describes their potential losses: "To infinity and beyond!" The only way for shorts to get out of a position is to buy shares -- to cover their shorts. What happens if those shares soar? And then, after they soar, what happens if they skyrocket? Infinity, you know, is a really big number.

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At time of publication, Alsin and/or ACM had no positions in the stocks mentioned, although holdings can change at any time.

Arne Alsin is the founder and principal of Alsin Capital Management, a California-based investment adviser. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback; click here to send him an email.