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Shorts Fight Fed, Win

But with open season on bears, how long can the strategy work?

These are heady days on the market's short side, where bearish investors have ridden stocks' repeated downdrafts straight to the bank and many expect the bleak party to keep raging. Face it, they say: The economy's weaker than ever and earnings estimates are coming down again following the terrorist attacks on Sept. 11.

But some think the dance is getting old. The habit of enriching oneself through short-term market declines has rarely stood up over long periods, some analysts note, and with Alan Greenspan's sights trained squarely on the market, bears could soon be an endangered species.

"I think the shorts are definitely a short-term strategy, perhaps one or two weeks following the onslaught of the attacks," said Tracy Herrick, markets strategist at Jefferies. "Within two to four weeks following money supply growth the market will be turning around. The Fed has basically told the shorts they're in trouble."

Downside Exuberance

Short selling, in which investors sell borrowed shares, hoping to replace them with cheaper ones and profit from a stock's decline, is more popular than ever. According to data from

Nasdaq, short interest, unsurprisingly, often peaks during market downturns.

One such zenith was in late summer of 1998, during the Russian debt crisis and Long Term Capital Management's meltdown. That spike was cleared in the ensuing bull market, although the level of short bets subsequently started rising at the end of 1999.

The latest data shows short interest hit another record high in the period before Sept. 11, rising 2.6% from mid-August to about 4.17 billion shares. Many believe higher levels will be reported for the month following Sept. 11.

Meanwhile, bear funds have chalked up the largest returns in the past month, according to mutual fund tracker Morningstar. Rydex Venture 100 and ProFunds UltraShort OTC have both returned more than 50% over the last month alone.

"There's a school of belief that says because of decimalization, the narrowing of spreads and Regulation Fair Disclosure, dealers aren't willing to absorb buyers the way they used to," said Phil Dow, director of equity strategy at Dain Rauscher. Dow cited a recent study that suggested that with decimalization, it's become easier to bid a stock down than to bid it up.

But Dow said shorting is riskier than ever, as a "tremendous amount of cash" could flood the market from the Fed's easing and "the last thing the Street's prepared for is positive commentary." Shorts will have to cover their positions at some point. "The market's vulnerable, probably more so now, to good news. Nobody's expecting good news, and if there's any,

the market could turn." For another take on the bear bet, see our

interview with Rydex fund manager Charles Tennes.

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It's A Bear

"That's another issue -- you could have a bear market for 15 years, but still have a bull market for two months," said Herrick, meaning that long-term trends don't necessarily confirm the wisdom of short-term bets. The Fed's easing could probably give the market a two-month boost, "but that's long enough to catch the shorts," he added.

But famed short-seller David Tice, portfolio manager of the Prudent Bear Fund, believes the current correction will be long lasting, reminiscent of three periods in the 20th century when stocks were stuck in a 17-year long downtrend. The current economy "is in a pronounced recession," not a "slight downturn," Tice said.

Tice thinks stocks are still too expensive, regardless of the recent selloff. "What does

Sept. 11 have to do with anything? We've had a consistent style and we've been warning about a bear market for a long time. We believe this is an overvalued market and investors ought to be careful and hedge themselves against a market decline," he said. The Prudent Bear fund -- the fourth-best performer on Morningstar one-month basis -- gained 27.73% in the last month, and is up 37.77% year-to-date, compared with the 21.2% drop in the

S&P 500.

Tice calls all talk about a cheap market "disingenuous," as the S&P 500 is still selling at a historically high multiple with 2002 earnings on their way down. Many companies trading on Nasdaq, like


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and various chip outfits, are overpriced, Tice argued. The selloff may have created some values, but they're only cheap "relative to the mania we've had before."

And it's not just tech that Tice considers pricey.

Procter & Gamble

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is "selling at 23 times earnings, and it had down sales last quarter," said Tice. "What's so cheap about it?"