When Shorting, Know All the Costs

The cause of this up bias is accumulated profitability. Like the market, corporate profits grow by 7% per year, on average. Business is always profitable in the aggregate, even during difficult economic phases (the Great Depression being the only exception). Therefore, to the extent that profit accumulation is virtually inevitable, then, so is the accumulation of value in the underlying business.

I recently read about a noteworthy hedge fund that is shorting Wal-Mart (WMT - commentary - Cramer's Take), General Electric (GE - commentary - Cramer's Take) and certain market indices. The strategy is predicated on the notion that the U.S. has a "housing bubble" that is about to burst, and this will hurt the likes of Wal-Mart, GE and the indices.

Related Stories

Finding Fixable Turnarounds

There is an overriding problem with this particular short, and all similar shorts. It's not enough to accurately diagnose a problem and the resulting consequences. Even if they're clairvoyant about the expected calamity, short-sellers have to be right on the timing as well. For instance, back in 1997 and 1998 there were many shorts warning investors about excess valuations in technology. They were right on the fundamentals of course, but way off on the timing. The Nasdaq more than doubled as prices went from irrational to more irrational from 1998 until 2000.

Now contrast the burden of short-sellers -- getting the valuation right, plus the timing, while paying the short tax -- with the burden of a value-centric buy-and-hold investor. Long-term buy-and-hold value investors only have to get the valuation right, and they don't have to pay the short tax, so they can afford to wait when they're wrong on the timing.

---

At time of publication, Alsin and/or ACM was long Eastman Kodak, although holdings can change at any time.

Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor and portfolio manager of The Turnaround Fund, a no-load mutual fund. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback and invites you to send it to [e-mail].