I felt like writing this piece over because I think people are still mystified by the process of a short squeeze. Most people think stocks go up because of the fundamentals. But those people who've been in the game long enough know better. They know that stocks can go up because they are promoted or because someone who is betting against some stocks has to buy them back or cover them. In the last few years, the latter has increasingly been the reason why stocks have flown up. I guess you could say that's when good things happen to bad stocks!
uncle, it is important to recognize that many of these outsized moves are outgrowths of some of the most amazing short squeezes in history.
(We saw something I thought I'd never see: a column by Herb in which he basically threw his hands up, saying he just couldn't take it anymore. As Herb speaks to short-selling sources, many of whom are excellent at their craft, I think he epitomized what I hear happening around the street. Good shorts don't go down. Great shorts go up furiously because so many people are short them. That's because in the last 10 years thousands of hedge funds have been established, and hedge funds are supposed to be short bad companies and long good ones so that they cushion you on the way down and still make you money on the way up. But, remember, I am a hedge fund manager and I think that's a big crock. The time when stocks represented companies' fortunes accurately ended a long time ago. I care about bad stocks, not bad companies. There are plenty of great companies with stocks I wouldn't want to own, such as Merck (MRK) - Get Report or Bristol-Myers (BMY) - Get Report. And there are plenty of companies that may not even exist in a few years that are represented by stocks I wouldn't mind trading. I thought of this dichotomy when speaking to Robert Samuelson, business columnist for the Washington Post/Newsweek syndicate. Oh, he was all over me about my so-called "damned the fundamentals full speed ahead" logic. Of course, that's hogwash. I live and breathe the fundamentals. But I'm like the general on the front lines, and I see the chaos out there firsthand. I know that the stocks that are going up don't represent the ones with the most profitability. They represent claims on the next potential Microsoft (MSFT) - Get Report or Cisco (CSCO) - Get Report. That's what the game's now about. And why not? Many of us have met millionaires courtesy of Dell (DELL) - Get Report or Microsoft or Intel (INTC) - Get Report or Cisco. We know it happened. If we can find that next one, even if it means losing on a bunch of others, we're going to make a fortune. I think Samuelson's beef -- and I suspect it's a beef because when was the last time someone from the press called who wasn't trying to put a pickaxe through my cranium? -- is that this process is somehow less rigorous than examining companies on a price-to-book or value basis. To which I say, if you don't think what I do is rigorous, then tell me why the heck it's so mentally exhausting and difficult, and lucrative.)
I want to focus on four particular squeezes, where bets against stocks backfired in a big, big way. Remember, when you short stock, you have to buy it back at some point -- unless it gets delisted. In these four cases, the stocks "got away" from the shorts. They just kept climbing and climbing and climbing, causing a house of woe to be visited upon those who sold shares short.
(Here is the core of this piece. So let's use the case of National Gift Wrap & Box company because these days when I suggest a short I run the risk of being skewered by BusinessWeek and I'm getting sick of having to call my lawyer to defend myself. Let's say I'm on the phone with the gift wrap analyst from Remarc Brothers Investments. Remarc Brothers, a brokerage, covers dozens of firms and its analysts are quite popular. The gift wrap analyst, Matt "FinePaper" Jacobs, tells me that he hears of a potential for a shortfall for National Gift because Champion papers is pulling its gift wrap line from National. It could mean a miss of as much as a nickel from his 15 cent estimate. Jacobs also swears that National GiftWrap.com is losing National Gift a fortune and is not going to be profitable until 2017.
Holy cow! The first thing I'd have done when I got that call is call the Stock Loan department of Goldman Sachs, where I keep my account, and say, "I want to borrow 100,000 shares of National Gift Wrap so I can short it." The Stock Loan department then tells me they have a "locate" on that stock. They can lend it to me because there are many National Gift shareholders at Goldman and they have kept their stock in the vault and it's available for hypothecation, and can be let out. That allows me to basically pretend that I own 100,000 shares so I can sell them. That's what short selling is. So, after I get my "locate," I go out into the open market and sell short 100,000 shares of National Gift at the prevailing price of $60.
A week later the stock is at $65. I call Jacobs. He says he hears that things have worsened at National Gift, that they may lose the St. Regis line of fine papers. I call Stock Loan again and borrow another 100,000. And I short that as the stock climbs to $80. Now I'm really getting killed. Sure enough, National Gift announces that it's selling the new Climax line of gift wrap and that Climax has taken a strategic stake in the company at $100 a share to help fund its dot-com initiative. Earnings are 10 cents better than the street was looking for. I'm livid. I'm dying! The stock opens the next day at $120. Goldman calls me at the end of the day and says they can no longer locate the stock they lent me. They have to find stock to send to real buyers and they're taking the stock they lent me and sending it out to them. I have to buy in my short or they'll buy it in for me. I'm outraged. I'm palpably frightened. I'm fearing I'll go out of business. I argue that if they wait, maybe other stock will come in for sale and I won't have to cover. They are nice; they give me another day. The next day the stock goes up again as Remarc Brothers recommends it. It's at $160. Goldman's stock loan department is no longer arguing with me. They go into the open market after the close and buy the stock in themselves, closing out my short. That's the biz! It's a perfectly legal action. They spike the stock in doing so, bringing it up to $200. I have to take a $200 buy price on my short to close it out. I have lost millions upon millions of dollars on these shorted 200,000 shares. I call FinePaper Jacobs and ask how could he do this to me. He reveals that he'd spoken to a hundred hedge funds all eager for short ideas and that he got everybody short, and that he feels real bad. And then he says, "Better luck next time" or "Easy come, easy go." There are so many hedge funds looking for short ideas that if you get one, someone else has it. And you get squeezes -- and that's precisely what happened to National Gift.)
The first is
, which was effectively chronicled here -- if not predicted -- by
in our fine tech coverage. People thought Rambus would be designed out; they are in big-time. Now the stock is grotesquely overvalued as the shorts try to reel the stock back, but the longs won't let them.
(Many people kept thinking that Rambus wouldn't get a key design win and then wouldn't deliver. So many hedge funds were short this that when it panned out, they were cooked.)
. People were worried that Oracle was having a soft quarter. Shorts pushed and pushed against this one, betting on some sort of negative preannouncement. Instead the company delivered on a colossal win in the B2B space. Shorts were -- and are -- being annihilated.
(We heard rumors that January was soft for Oracle. Sounded like a good short. But all of this other good stuff came along and the shorts were clobbered.)
Third on the short hit parade is
. The smart money was betting that 3Com was going to have a crummy quarter, hit by Cisco's aggressiveness in the space. But the
spinoff wrecked those nightmares. The losses for the shorts here are just huge.
(The short logic here is awesome. Palm is overvalued, the business of 3COM 'aint that great. Combustible. But what if Palm is worth $50 billion? Oops, didn't count on that!)
Finally, how do you spell pain if you are short? Take a look at
. Just check out the chart. I don't need to say any more. This was a massive squeeze and it is taking people apart. Daily.
(This one is gruesome. I have no comment on it, except to say that this is one of the great battleground stocks of all time.)
James J. Cramer is manager of a hedge fund and co-founder of TheStreet.com. At time of publication, his fund was long Cisco, Dell, Goldman Sachs, Intel and Microsoft. His fund often buys and sells securities that are the subject of his columns, both before and after the columns are published, and the positions that his fund takes may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column at