Cramer's Rewrite of His 'Rhythm of the Shorts' Column

The trader looks at how innuendo and the end of the quarter intersect.
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This piece, which rewrites a Thursday column, is a deeply cynical one that I wish I did not have to write. It reveals a subculture of rumor that underlies much of what passes for "trading action" on Wall Street. The ability to knock stocks down is an important weapon in the arsenal of some hedge funds, and this article examines that process. I want to say at the outset that trafficking in rumors, leaking rumors, spreading rumors is something that I have railed against publicly and privately for more than a dozen years. Nonetheless, it goes on, and I want you to be aware that it goes on. Every day. But especially right now. And this piece was extremely topical for Friday's action.

The rhythm of the shorts. That's what the ramp was yesterday. Here's a time-honored pattern that you will thank me for once you spot it as often as I do.

(Lots of slang here, so let's break it down word for word. The shorts I am referring to are stocks that are shorted with the prospects of bringing them in -- or covering them -- after word leaks out of pending bad news. "Ramp" is a Street term for a quick move, usually associated with an aggressive buyer or an aggressive short-coverer. We never use terms like "increased by" -- we say, "ramped"! When I say "time-honored pattern," I am being very cynical because it implies that there is pure manipulation going on here. Some of it is manipulation; some of it happens to be the vicissitudes of business and the problems that occur when you are running a complex tech business.)

We are now in the quiet period.

(Quiet period is the informal name of the period that begins one month before the end of a quarter. For the first two months of a quarter, you can get general guidance from a company about how business is. But once you approach the last month, you cannot even ask about how business is without running afoul of the SEC-supported rule forbidding managements from leaking how a quarter will finish. When companies "go quiet" they are defenseless, as we shall see. Why have this rule? Because the SEC doesn't want some people to know how one company's quarter finished and not others. It wants a blackout and then a broad dissemination of the news.)

That's raidin' time! That's when traders who live under rocks surface to say they hear that

National Gift Wrap & Telco

didn't make the quarter. Of course, because we are in the last month of the quarter, National can't comment to refute the subterranean allegation. (Them's the rules; I don't make them.)

(When we are in preannouncement season, which happens to be the same time as quiet period, companies discover whether they can meet the guidance they helped create for Wall Street. So National Gift might have, at the beginning of the quarter, guided "the Street," or the analysts who cover the stock, to a particular range of earnings, let's say 35 to 40 cents. Throughout the first quarter, until quiet, they will confirm whether that guidance will be met, exceeded or, possibly, fall short. As so much business is done in the last month of each quarter, though, you run the risk of not getting the full picture. Let's say going into the quiet period National is confident it can do 38 cents, but that a key customer cancels business and another important customer defers an order. Now 38 cents is a definite no, and instead 33 cents looks more likely. Here's a real gray area. Is 33 cents "well below" the Street's expectations? One rule of thumb is that if it's 10% below expectations, the company should preannounce things. But remember it initially said that it could do 35 to 40 cents. Some companies may not preannounce, but when they report 33 cents, people will be pissed off and declare it a crummy quarter. So, the company might try to make it back to 35 cents at the end of the quarter and we would not know the difference other than it reported at the low end of the range. Now, let's say that several orders collapsed and Brazil crushes National, all during the quiet period, and National thinks it's going to earn 30 cents. It has to preannounce. This development is your worst nightmare. That's what happened to 3Com (COMS) this week. Keep in mind, though, preannouncements are closely guarded secrets. Companies do their best to keep everyone outside the company from knowing. Nevertheless, if you know that National has had order cancellations -- because you know the customers that cancelled them -- you very well might be thinking that National might preannounce. So, you want to get out ahead of that or short National. You go and buy puts on National. Your broker wants to sell the puts to you, but he does not know whether he should hedge himself. He asks you: "Will I be okay, or is National in trouble?" If you don't want to bag him, you will say, "You are not okay, don't short those puts to me." Boom, that lets the word out. Then a million different customers are hearing that National blew the quarter. Next thing you know, National's stock is down three points. National doesn't want to call analysts because it is in quiet. National can't really defend itself. Sometimes National's counsel will relent and say that silence has become "material" and can't be justified. But for the most part what happens is that National gets "raided down" by this activity. I have stated it in as a benign way as possible. It is entirely possible that a short-seller might get short National and then "leak" it to other traders, even reporters, that National is in trouble. That also gets the stock down and the same goal -- profiting off the alleged bad news -- is realized. All of this works because the company can't call and tell its defenders, the analysts, that all is well, without tipping its hand and violating "quiet.")

This raid is especially powerful if most of National's execs are on a plane somewhere to Singapore or stuck in board meetings and can't be beeped. You can see the put-buying and the shorts pressing their bets.

(Sometimes really devious traders will realize that nobody is around and really go to work on companies. I remember that in the bad old days, when this stuff was much more prevalent, speaking to managements at Cabletron (CS) - Get Report and American Power Conversion (APCC) . I pleaded with people to issue statements and then discovered that no one was home in corporate headquarters. You knew you would take a severe long-side beating when that happened. Pressing a bet means that someone is increasing the amount of money he may be betting short a stock.)

What then happens, of course, is anybody's guess. Sometimes the raid succeeds, and the stock cascades and the shorts cover profitably. But sometimes they get a smack to the head because the company somehow leaks that it is


going to have a conference call at the end of the day to guide down numbers. In other words, it gives guidance by not giving guidance! No conference call? No blowup. No blowup? No juicy price to cover. No juicy price to cover? Short squeeze.

(Here is the crux of the way the game is played now. A company may not be able to say, "Hey, this stuff is nuts, business is darn good. In fact, we will do the 38 cents we said." It can deny that there will be a conference call after the close. But don't bet on it. About 10 years ago I lost a fortune in Storage Tech (STK) - Get Report because there had been rumors that it would preannounce after the close on a Friday, and I called investor relations to ask if there was a conference call because the stock was so heavy. The IR said "absolutely not." There was, and the stock got cut in half the following Monday.)

Yesterday, for instance, there were rumors that


(INTC) - Get Report

was going to have to preannounce to the downside. I heard these vibrate despite my day off spent with the wife and kids. But they weren't true. (That's the same as saying they were a lie, by the way.) And the stock flew as shorts frantically covered.

(This exact same set of circumstances occurred Friday, when rumors of chips being returned from major personal computer makers made the rounds. Fear that either Intel or one of these computer companies would preannounce after the bell caused Intel to reverse midday. I wrote in the morning that if I could buy Intel in line I would play this squeeze, but it went up too much at the opening. By midday the rumors resurfaced and the stock swooned. It is amazing that a major stock could be held hostage to such innuendo like this, but most of the Street says "where there's smoke there's fire." Meaning that traders think if Intel were having a blowout quarter, it would not be going down so easily. I always want to buy these situations, but my partner, Jeff, doesn't. He thinks playing the squeeze is too dangerous vs. the downside if something is really wrong.)

That's the rhythm of the shorts.

(Apologies to the great Paul Simon for ripping off Rhythm of the Saints.)


Investor's Business Daily

says: Read it, learn from it and profit from it!

(I don't know why I wrote this other than that I hear the commercial a hundred times a day, so I put it in. I would caution you that all next week we will see this same pattern, as the last month of this quarter is when most companies "go quiet." Be aware that if no preannouncement occurs, there will almost automatically be a squeeze up as discouraged short-sellers come in and buy back their shares or buy common stock against puts.)

Random musings:

From the "Stop Me Before I Immolate" Department: I am buying more long bonds.

(I sold these bonds when they were up two points on Friday. I will probably buy them back if bonds go back to 5.70 on the 30-year. This was a good trade.)

James J. Cramer is manager of a hedge fund and co-founder of 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 by sending a letter to at