The Short Side's View: Still Plenty of Complacency to Get Rich On

With Robertson and Soros out of the way and some indicators still showing optimism, short sellers sense good times (for them) ahead.
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One of the great unintended consequences of the departures of Julian Robertson and George Soros is the impact on short sellers. Robertson and Soros' exits have made it far easier for other professional investors to short stocks than it had been in several years, according to several dedicated short sellers.

In their heyday,

Soros Fund Management

and, even more so, Robertson's

Tiger Management

not only made global bets on currencies and entire stock markets via the futures markets, they also shorted billions of dollars worth of individual stocks. When they quit, they liquidated not just their macro bets but also

their individual shorts

. Because they had been running billions of dollars on the short side, their leaving cleared the field for those bears left standing.

One of the eternal challenges of

short selling is borrowing stock. If you can't borrow a stock from a broker, you can't short it. Even if you have borrowed the stock, the broker can call it in -- i.e., take the shares away from you -- if he wants. This fact of life makes the mechanics of shorting complex and unpredictable. And the more other short sellers are out there wanting to short what you think is the most hyped and overvalued stock of the week, the more difficult it is to borrow the stock. Get rid of Julian and George, and stock becomes more available.

You should care about this, but not because everyone ought to rush out and give short selling a whirl. (You could have gotten killed on a day like today if you had gotten short in the morning before the snapback rally.) You should care because their leaving comes at a time when speculative short selling is even more unpopular than usual. Put it all together and you have to wonder how we could be at a market bottom when so few people are bearish.

The decline of short selling can be tracked in any number of ways. Anecdotally, I can say that the October-March rally in tech stocks cleaned out at least two short sellers I have known since the late 1980s, one in New York City and another in the Bay Area. Other bears have capitulated and gone exclusively long. I know of only one short seller with more than $1 billion in assets under management. That is peanuts on Wall Street. If you added up all the money run by dedicated shorts in the U.S., it would probably not come to much more than $2 billion to $3 billion.

For those with a more quantitative inclination, the

New York Stock Exchange and the

Nasdaq Stock Market report "short interest" figures monthly. Monday, the NYSE reported a 4.3% rise in April in the level of short sales not yet closed out. The

American Stock Exchange said short interest rose 2.2% last month. Short interest is sometimes considered a contrarian indicator, as short-interest shares eventually must be repurchased to close out the bet.

But these figures obscure as much as they reveal about what may actually be going on in Short Land. Much of the short selling picked up in the data may be nothing more than positions intended to hedge trades in the futures markets. Such data tell us little about how many traders are actually betting that the market is headed lower. To get at that, it can be more useful to look at the short interest in specific stocks.

Say you want to get a handle on whether a lot of people are betting against tech stocks. One trader who goes long and short says that he tries to gauge such sentiment by looking at specific tech bellwethers like

Texas Instruments

(TXN) - Get Report

. In the case of "Texas," as he calls the company, short interest last month actually dropped. "That and other examples tell me that people are not really short tech," he says.

He also pays attention to the "commitment of traders" data on the S&P futures. (These data are routinely reported in

Barron's

in the Commodities and Financial Futures section.) When people trade stock futures they must identify themselves as either hedgers or speculators. When you look at the speculators, they are still hugely long, not short.

This short seller takes the commitment-of-traders data as, not surprisingly, a bearish sign: "We have come down a long way on the

Nasdaq

Comp

, but my observation is that there has been relatively little selling of tech. Most of the decline has come on low volume. People still view this as a correction, not a bear market."

Midday, when the Comp was still in the red, he said that he wanted a rally after five consecutive down days. "I was hoping for a bounce up that I can sell short into," he said. He got just that this afternoon. What does he make of it? The large-volume rally gives him pause, and he expects today's rally to continue for some days.

But he adds that "the put/call ratio was still very low today even when the market was near its lows. That tells me that even after all the declines of late people remain very bullish. People are still very quick to turn bullish. There is no fear in the market. That is not typically the kind of mood you get at market bottoms."

His next move? Short the coming rally.