What Goes Up... Pass The Beer Nuts.
The battle of the uptick continues unabated despite the fact that the campaign it underlies lacks even the most ethereal semblance of foundation. It takes no more thought than the realization that certain prices, (gasoline, crude, wheat, corn, soy, cotton) are not expected to trace an ever-upward path, or at least that it is considered bad if they do, to recognize the pure and rank hypocrisy that is the misguided "War on Declines."
Consider for a moment the implications of "up only." Are there no equities, none at all, that will, in fact, turn out to be overpriced today? That is, that the net present value of the total sum of their actual future cash flows for any reasonable discount rate is far exceeded by the current share price of the issue? A moment's reflection on this basic thought experiment should lead the erudite finem respice reader to the inevitable conclusion that any attack on short sellers is akin to the concept that mere belief in overvalued equities, much less the willingness to back this up with cash, is problematic.
What is required is to understand short selling for what it is: an attempt to reallocate capital away from inefficient or overpriced ventures to more efficient or underpriced assets (even cash). At this most basic level, it is difficult to find fault with the concept. Despite this, much noise is made of the volatility caused by short selling. This, of course, is bunk.
Contrary to the premise that the market needs the shock absorber of the uptick rule and its ilk, short selling is, itself, a shock absorber. The fact that Harry Markopolis went out of his way to expose Bernie Madoff, despite little or no incentive and no semblance of direct benefit to himself is a remarkable exception to the general rule. Imagine, however, that there were some financially incentivized method to "short Madoff." Imagine, also, that such downward and illuminating pressures did not require the work of a regulator to halt the Madoff fraud. Would the "Madoff bubble" have swelled to such size? Are not over-inflated asset prices which endure no downward pressure far more likely to explode into volatility fireworks than those subject to the constant and skeptical downward pressures of short sellers? In this context it is important to understand that the professional short seller has everyone working against him. For the short seller being wrong is a loss. For the company he shorts, and its senior executives, failure is career death. It is easy to see that short sellers likely have the most difficult and intense research jobs in the industry. Charlie Munger, somewhat famously, said of this paradox:
It would be one of the most irritating experiences in the world to find something crooked, and to short it, at X, and watch it go to 3X, and to watch them happily sloshing around in your money while you're meeting margin calls. Why would you want to go within hailing distance of that?1
Add to this what can only be seen as the current state-sponsored campaign by no less formidable enemies than the United States Treasury and the present Administration to impose a general short-squeeze and you might have some sense of the forces presently aligned against short sellers.
Given the high burden on short sellers to be right, and the forces allied against them, it is no surprise that this class of investors tend to be among the cleverest, best informed and most careful researchers. It should surprise no one that short sellers, and not the SEC therefore, are among the chief whistleblowers in the securities markets.
The tendency to demonize short sellers is part and parcel of a larger sickness in the market: the "ever up" philosophy that is linked at the hip with the misnomer that the retail investor is, de facto, entitled by right to 8% returns year after year. Notice, also, that no one seems in a hurry to ban the unpatriotic and evil "put option." This, of course, is merely a matter of practicality, as the complexities of short selling and the specter of borrowing shares to accomplish it lends itself to criticism and anti-insider class warfare. Naked short selling is, of course, an issue, but not one that needs to be managed by wholesale bans on the practice of short-selling.
Volatility is a convenient crutch to support misfeasance and even malfeasance in securities markets, as well as plain old incompetence, but the anti-volatility argument holds little water for those willing to examine the underlying issues critically. If, instead, we embraced short selling, made the practice not only acceptable but accessible to the brave and diligent investor, it is difficult not to see that volatility, and bubbles, grow as we reduce downward pricing pressure on markets.
Let's, shall we, dispense with the fiction that the only honorable or patriotic way to make money in the securities markets is by going long. It is no more patriotic to sink money into inefficient, hyped businesses benefiting more from the pages of pulp fiction that are today's generally accepted accounting practices than it is to burn billions propping up General Motors when it is obvious to everyone that the company has been decaying in its own grave for years. Convert the public image of short selling into the legitimate investing tool that it is and watch markets stabilize, confidence in pricing buoy, and frauds exposed early instead of disastrously late. Of course, this will irritate those who have benefited for years from the manipulation of accounting, short-selling bans and curbs, and the rest of the bull-only bullshit that seems to pass for market "regulation" today. Tragic, no?
- 1. Rick Casterline "Berkshire Behind the Scenes: Part 5," The Motley Fool (June 6, 2006).
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