By Lynn Thomasson
Feb. 9 (Bloomberg) -- The biggest bears in U.S. stocks are losing their conviction after the steepest decline in the Standard & Poor’s 500 Index since the Great Depression.
The number of shares borrowed and sold short on the New York Stock Exchange fell 28 percent last month from the peak in July. Companies in the S&P 500 trade at the lowest multiples of earnings in 18 years. President Barack Obama is working with Congress on a spending and tax-cut plan of about $800 billion to revive the economy, and regulators are imposing stiffer oversight on speculators.
While Seabreeze Partners Management Inc.’s Douglas Kass and David Tice at Federated Investors Inc. say there’s still money to be made betting that food and computer makers will fall, even Marc Faber, who publishes the “Gloom, Boom & Doom Report,” abandoned his so-called short positions. Bill Fleckenstein, who warned of the housing bubble in 2005, closed his 13-year-old bear market fund and bought shares of Microsoft Corp.
“It’d be easier for me to find five stocks I think are going to go up than five stocks I think are going to go down,” said Fleckenstein, who is based in Seattle. “Being short right now just feels like the wrong strategy.”
Most U.S. stocks fell today, snapping a two-day gain, as concern President Barack Obama’s stimulus package won’t be enough to pull the nation out of a recession outweighed a rally in financial and industrial shares.
28% Gain Last Year
Short sellers, who borrow stock and sell it on hopes of capturing a profit by replacing the shares after prices fall, had the most success among hedge funds last year, gaining 28 percent on average, according to Chicago-based Hedge Fund Research Inc. The S&P 500’s 38 percent decline last year was the biggest drop since 1937. Only 24 shares in the index rose.
Short interest, the number of shares sold short, totaled 13.4 billion on Jan. 15, down from 18.6 billion in July, based on data compiled by New York-based NYSE Euronext.
U.S. stocks trade at an average 15.23 times earnings after falling as low as 15.20 in November, the cheapest since 1990, based on an analysis by Robert Shiller, the Yale University professor whose 2000 book “Irrational Exuberance” predicted the market’s collapse. His analysis uses a decade of earnings to smooth out short-term fluctuations.
“I would be very cautious about being short this market right now,” said Dan Veru, who manages about $2.4 billion and can bet on gains and declines in equities as chief investment officer of Palisade Capital Management LLC in Fort Lee, New Jersey. “It’s very dicey.”
Kass still expects to profit from betting cash-strapped consumers will switch to generic products and drive down shares of Northfield, Illinois-based Kraft Foods Inc., New York-based Colgate-Palmolive Co. and Kellogg Co. in Battle Creek, Michigan.
Kraft, the maker of Kool-Aid drink mixes and Jell-O desserts, fell 9.2 percent Feb. 4, the steepest drop since 2003, after saying earnings will be less than its earlier forecast. The median company in the S&P 500 index of food producers, tobacco growers and grocery stores trades for an average 13.1 times earnings, the highest level among 10 industries in the gauge.
So-called consumer staples companies, which posted the smallest drop in the S&P 500 last year, are down 5.8 percent in 2009, underperforming the benchmark index by 1.9 percentage points. Colgate dropped 4.2 percent this year, while Kellogg, the biggest cereal maker, slid 0.6 percent.
“You’ve got to be a little more creative,” said Kass, who oversaw $200 million as of October for Palm Beach, Florida-based hedge-fund firm Seabreeze. “These are companies that face long- term challenges to their business model. Investors are going to see that.”
Tice, the Dallas-based strategist for the $1.1 billion Federated Prudent Bear Fund, anticipates a 50 percent drop in the S&P 500 this year and says technology stocks and retailers will retreat. The fund, which increased 27 percent in 2008, beat 96 percent of its peers in the past five years, according to data compiled by Bloomberg.
Intel Corp., the world’s largest chipmaker, may report a first-quarter loss, Chief Executive Officer Paul Otellini wrote in an internal memo last month. That would end a 21-year run of profits for the Santa Clara, California, company. Technology stocks are the third most costly in the S&P 500, with the median company trading at 12.4 times profit.
“There are a lot of people feeling as if technology earnings are going to be OK,” Tice said in a Feb. 5 Bloomberg Television interview. “We think they’re going to be coming down a lot.”
Profits for S&P 500 companies fell 39 percent in the fourth- quarter, the steepest decline since Bloomberg began tracking the data in 1998. The recession, forecast to last for another five months, will drag earnings down an average 30 percent this quarter and 25 percent the next, according to estimates from analysts and economists surveyed by Bloomberg.
The S&P 500 began recovering an average five months before recessions ended in 1975, 1982, and 1991, data compiled by Bloomberg show.
Declines that erased almost $29 trillion from global equity markets last year convinced Fleckenstein to close his short fund in December after falling valuations made it “too dangerous” to bet on more losses. He said the fund had a “great” year in 2008 and declined to comment further on its performance. Fleckenstein plans to start a fund this year that both buys and bets against stocks.
Fleckenstein bought shares of Redmond, Washington-based Microsoft, which traded at 9 times earnings last month, the cheapest since at least 1987. At the height of the technology bubble in March 2000, the world’s largest software maker traded at 69.8 times profit.
Faber, who is purchasing Asian stocks with some of the $300 million he oversees, told Bloomberg Radio Feb. 6 that he bought back the shares he shorted because investors speculating on an economic rebound may push the S&P 500 up 19 percent by May to 1,037. The index closed at 868.6 on Feb. 6 and rose 5.2 percent for the week.
“Short selling is down because prices are down and because some regulation came in that made it very difficult,” Faber said. “You could make a case that in the U.S. that some equities have come down a lot and are inexpensive. Resource-related shares have totally imploded.”
Metals and chemicals stocks in the S&P 500 dropped 47 percent in 2008, the second-worst performance behind financial companies, which plunged 57 percent. Both annual returns were the worst since Bloomberg began tracking the data in 1990.
Should the S&P 500 rally, losses for investors who wager on declines could be magnified by a short squeeze, a rally caused by investors closing out bearish bets. The U.S. stock benchmark gained 15 percent since reaching an 11-year low Nov. 20 on the prospect that record low interest rates and Obama’s spending plan will jumpstart economic growth.
Short sellers face more scrutiny from governments in the U.K., Japan and Australia after the FTSE 100 Index, Topix and S&P/ASX 200 suffered their worst year on record with losses exceeding 31 percent.
Regulators are requiring speculators disclose more information about their bets, enabling rival funds to exploit them for their own profit. Britain’s financial regulator plans to require investors list short positions on more than 3,000 shares traded on U.K. exchanges, it said Feb. 6.
‘No Rational Basis’
The U.S. government banned investors from shorting financial companies in September after executives complained bearish traders were spreading rumors to drive down prices. The rule, which affected more than 900 companies, expired Oct. 8.
Morgan Stanley Chief Executive Officer John Mack told employees in a September memo that management was acting to stop “irresponsible action in the market,” and said there was “no rational basis” for the depth of the share-price declines. The New York-based bank tumbled 44 percent that month, the most since Bloomberg started compiling the data in 1993.
“It’s a little more difficult now,” said Tice. “There are still lots of possibilities, but we have to be a little more judicious.”