Mad Dash to Nasdaq: Shorts Feel the Pain

Short-sellers complain that the market rewards speculation and momentum, not diligence and insight.
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Jean de La Fontaine weeps.

For the grasshoppers of the market have been dancing through the winter, flourishing as any and every tech stock gathers momentum, as any name with a tangential relationship to a gaudy trend rises. The ants -- those few diligent investors attempting to research companies, find out which ones are or will actually become profitable and, importantly, which ones are not -- suffer. The ants suffering the most are the short-sellers.

Indeed, about the only people who are out of jobs in this full-employment economy are the professional skeptics: the short-sellers. The ranks keep thinning and thinning. Just last week, one veteran San Francisco short, Alan Fenster, closed up shop, sending a letter to his investors declaring that his days are past. "He was one of the old granddaddys, a very smart guy," says a West Coast manager of a short-only fund. "It's insane out there. It's as bad as I have ever seen it." Fenster didn't return a call seeking comment.

David Rocker, who runs a short-only hedge fund, says: "The sad thing about the market is that many extremely bright people are having terrible years, while many of those having spectacular years are the borderline irresponsible."

Silver and Gold

That is Gresham's Law: The bad drives out the good. To understand the law, think of two coins, both worth the same nominal value. One is made of gold and the other of tin. People will hoard the gold and let the tin circulate. The "bad" coin has driven the "good" one from the market, an economic tenet so basic that they teach it in home economics.

Dash down some thoughts on our Nasdaq board

That's what this phenomenal market is, no more and no less, the shorts say. The

Nasdaq Composite Index

, loaded with the types of hype jobs that investors currently slather over, is up more than 60% this year, having added some $2 trillion in market capitalization over the past 12 months. That's the equivalent of more than a fifth of U.S. GDP, the sum of a year's work of millions of people in several million businesses, of garbage collectors and steelworkers and nurses and even Mary Meeker.

From the shorts' point of view, the market has been rewarding speculators whose chief interest is in buying something because it was up yesterday. They get money from investors, they get the bonuses, the big apartments on Central Park West, the promotions, the adulators and mimics. Anyone who uses the word "bubble" is a ninny.

Evidence of Gresham's Law falls broadly over stocks: Price targets raised indiscriminately, ignorance of balance sheets and whole sectors blindly flying despite the fact that some companies must be stronger than their competitors. Rocker points out that another basic economic law is that as interest rates rise, the companies that are hurt are those whose profits are further away. But those are exactly the companies now performing the best.

Full-Court Press

One of the scariest aspects of this market is that third-tier outfits are rising like everyone else. Take



. This notorious name, one of the celebrated shorts of years past, hit 100 in May 1996. It then collapsed, falling to the single digits, where it spent the last year.

Then, on no news to speak of, the stock revived in late October. As of Thursday, Presstek is up 125%. This is a company whose founder had to pay $3 million to settle

Securities and Exchange Commission

charges about hyping the stock. The West Coast short-seller says, "When I say third tier, I mean these are the technologies that


worked. This is why I'm getting killed."

The fable has a moral, however. It's a one-word moral:



. That was a mo-mo favorite, a roll-up conglomerate darling with a CEO who could do no wrong. It rose and rose, all the way up to 53 and almost $100 billion in market cap. Until it stopped. Until there were questions and a taint to the story. Then it fell and keeps falling, down 7 7/8 Thursday to 28 3/8. It remains to be seen whether the defense of analysts Friday will be able to stanch the bleeding, though it was rebounding slightly today.

That reveals the dark side of momentum. Both moves are irrational and extreme. The questions about Tyco revolve around the balance sheet, something that is widely available to all investors. Investors might have analyzed the company's finances at any time. Instead, they simply (and in some cases unthinkingly) bought a "good" story; now, using the same follow-the-herd thinking, they sell a "bad" one. In other words, it was a phenomenon going up and equally one going down.

Alors, danser.