Ted Stamas'  Instablog

Robert Sloan's Don't Blame The Shorts not only delineates the history of short selling in America, but also chronicles the centuries old chasm between Main Street and Wall Street. Sloan starts spinning his yarn right after the Revolutionary War and states: "Many felt in 1790, as many do now, that compensation made through financial speculation is unjust, and short selling is the most unjust of all.". So begins the tale that is not an edge of your seat page turner, but a clear and concise historical account that will be of interest to students and participants in the capital markets system.

A common thread throughout the book is that after each boom and bust cycle in the stock market, populist fervor against short selling explodes in the aftermath of the crash. As Sloan notes: "The argument against the shorts were designed to appeal to the uninformed and easily scared masses, and history would allow this particular scapegoat strategy to be so effective that it would resurface with each subsequent financial crisis through the twenty-first century.". Time and time again the government would become involved with Senate subcommittee hearings, but could never prove that short selling was a cause of stock market implosions.

As to be expected, a good portion of the book covers the 1930's and The Great Depression. Both Hoover and FDR spearheaded investigations into short selling and the bear raids that were supposedly the cause of the country's economic strife even though short selling only accounted for 5% all exchange transactions from 1929 - 1932. There was such a stigma attached to being a short seller in the 1930's, that in 1932 the New York Times published the names, addresses and photos of those who were short more than 2,500 shares of a stock. However, the author does not believe our current crisis reflects the era of the 1930's, but more or less parallels that of the Crash of 1907 when overpriced real estate caused a run on the banks.

You can infer from the title Don't Blame The Shorts that author Robert Sloan is pro short selling and in fact, is of the opinion that shorting is good for the markets. As Sloan remarks in the epilogue: "Short sellers function as the police officers to markets - the editors - the very checks and balances our forefathers envisioned. The shorts are a disinfectant, shedding light where there is only corporate darkness.". I liked this book. It was short and to the point and very well researched. As we are living in an era of history repeating itself, Mr. Sloan depicts the negative market psychology that has transcended Wall Street since the birth of our nation.

"Beta Slippage" is fairly new to the financial lexicon. It is associated with the effects compounding will do to leveraged ETFs and leveraged mutual funds. I was aware of its attributes and consequences long before I invested in ProShares Ultra Short S&P 500 (SDS), but noted a detailed explanation of it in Robert Prechter's Conquer The Crash. It basically states that because leveraged ETFs are rebalanced daily, you may or may not replicate the performance of the index you are invested in if you hold these instruments for the long haul. I think it is stated best in a ProShares FAQ: "Due to compounding, the return of these funds over longer periods may be more or less than the daily market multiple. Compounding tends to help returns in upward and downward trending markets and tends to reduce returns in volatile markets. The positive and negative effects of compounding are significantly magnified in leveraged funds.".

Here is an example from an article by Michael Iachini from the Schwab Center for Financial Research on a long leveraged ETF: "Consider a hypothetical ETF that promises twice the return on an index. Let's say you buy a share of the ETF for $100 while the underlying index is at 10,000. If the index goes up 10% the next day to 11,000, your ETF should go up 20%, to $120. If the index goes from 11,000 back down to 10,000 the next day, that's a decline of 9.09%, which means the ETF should go down twice as much, or 18.18%. A decline of 18.18% from the $120 price of the ETF should leave it at $98.18. So even though the index ended up right back where it started, the ETF is down 1.82%!". Caveat emptor. Let the buyer beware when investing in leveraged ETFs because you are playing with fire.

As I reflect on the negative returns in this portfolio the past four months, expressions like numb skull, chowder head and lame brain come to mind, but I digress. The objective of this blog is not to track my original investment in the short-term, but over a multi-year period. The market could boomerang any day now causing a seismic shift in investor sentiment. I refuse to pull the plug on my original investments because I've only held them a few months. Many influential analysts are currently bearish on the markets and believe we are in a bubble no matter how optimistic the government is. My belief if that if I were to sell my shares of ProShares Ultra Short S&P 500 (SDS) and go into cash or go long, I'd only be whipsawed when the smoke clears. Housekeeping is not in order at the moment, although in a what have you done for me lately world, it is difficult not to second guess myself.

My last post was a review of the above mentioned book Conquer The Crash and I will continue to review books on this blog as long as they cover the subject of investing and remain within the spirit of the overall milieu of my original premise. In fact, since I am an infrequent trader and not an economist, I will probably be reviewing many investing books here to keep the content fresh and the readers coming back for more. At least that's the plan for now. Next on the docket is Don't Blame The Shorts: Why Short Sellers Are Always Blamed For Market Crashes and How History Is Repeating Itself by Robert Sloan. It will be posted next week.

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As I'm whistling past the graveyard with my short positions, the market continues to rally. I remind myself that you should never invest more than you can afford to lose, but right now I've lost nothing because I haven't sold anything although I'm taking a whopping paper loss. It is with absolute certainty that I doubt myself every day, yet I still forge on with my convictions of a double dip recession. I know it's touch and go for the next month or two if history is any indicator because the market tends to rally in November and December. Right now there are two divided camps on Wall Street on where the market is heading untill New Year's Eve. The bulls believe that mutual fund managers and retail investors will continue to chase momentum forcing the market higher. The bears think that money mangers will start to sell stocks to lock in their yearly profits and the market will correct. How do I know all of this? By watching CNBC.

Financial networks like Bloomberg, CNBC and the fledgling Fox Business News are a relatively new phenomenon for both the individual and institutional investor. CNBC came of age only 20 years ago with the advent of the national cable television build-up. Before the birth of CNBC, you'd get your business news the day after in print from newspapers like The Wall Street Journal. Now information is absorbed instantaneously as it hits the airwaves and the Internet. I am not implying that it levels the playing field because the institutional investors still have the inside track with the Old Boy Network, but it does help.

I'm a stock junkie. I watch CNBC all day, but don't recommend it for most retail investors. A majority of financial experts agree that for your Average Joe on the street, you should check your portfolio once a month or once a quarter and re balance if need be. Watching the vicious swings in the market makes you apt to trade more frequently especially as guests on the financial networks discuss the minutia of a one point move either up or down for a security. Trading more frequently makes you lose money which is why women tend to be better investors than men - they trade less often. Watching networks like CNBC can make you trigger happy if you are near a computer and have an on-line account with a brokerage firm. It is too easy to trade, particularly when you are inundated with "experts" jawboning about the virtues of a stock that may or may not be a good value. Rarely do I get a stock tip I can bank on from watching CNBC, but I do get plenty of economic news.

It has been said that astrology was invented to give credibility to economics. Take a piece of economic data, give it to 30 economists and you'll come up with 30 different interpretations. This is proven time and time again on CNBC where nobody agrees on anything. It is great for an open discourse, you will get both sides of the story, but who is right and what advice should you follow? This is the hard part. The power of persuasion by some of these economic alpha dogs is second to none whether they are right or wrong or what track record they have. I still watch CNBC because you do get valuable information, but you have to know how to parse it. That is why I believe you should get most of your economic information through reading. Any financial portal on the Internet will do.

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In the twenty years I have been investing, I'm currently the most diversified as I've ever been in any of my portfolios. I only own two ETFs, but these two Exchange Traded Funds mirror the performance of major domestic indexes and both are to the short side. The ProShares Ultra Short S&P 500 (SDS) tracks the S&P 500 which consists of the largest 500 American securities by market cap and the Direxion Small Cap Bear 3X Shares (TZA) emulates the return of the Russel 2000. I tend to be an aggressive investor, so I am usually running a concentrated portfolio with very little diversification. If I had been diversified throughout the years, I wouldn't have tripled my portfolio in a matter of one or two years twice in previous bubbles. I also wouldn't have lost as much after the party was over as I hung onto my positions like Captain Ahab harpooning the great white whale. Always remember that tried and true Wall Street adage of "don't confuse brains with a bull market". I learned the hard way which is why I'm short right now because I really believe in my convictions of a double dip recession.

I have been asked what I would do if I wasn't so aggressive in my investments and took more of a laissez-faire attitude in portfolio management. After all, this is what most people would prefer to do, take a hands off approach and let their money compound at a reasonable rate. Investing in the stock market can be very confusing with all of the choices available and even if you know what you are doing, you can get burned like the majority of people did this past year. If I didn't have an ego large enough to think I can beat the market, then I would be as diversified as possible with index ETFs covering domestic and foreign securities as well as good old American bonds.

Which ETFs would I purchase to build a diversified conservative portfolio? For me the prudent course of action would be to invest in ETFs offered by Vanguard because they have the lowest expense ratios. As a side note here, it should be mentioned that pioneer discount broker Charles Schwab launched some index ETFs this week with a slightly lower expanse ratio than the Vanguard offerings, but they are new to the game and will have very low volumes at the outset. Vanguard is synonymous with index funds and really knows what they are doing are far as managing their product is concerned. I'll stick with the tried and true.

For my laissez-faire portfolio, I would divide my cash into the equal parts of roughly 33% each and invest my money in the following three ETFs offered by Vanguard. For domestic coverage, the Vanguard Total Stock Market ETF (VTI) tracks the MSCI U.S. Broad Market Index. This contains 1,200 - 1,300 of the largest cap American stocks. For foreign exposure, the Vanguard Total World Stock ETF (VT) tracks the FTSE All-World Index of 2,900 stocks from 47 countries. Finally, for a bond allocation, the Vanguard Total Bond Market ETF (BND) tracks the Barclay's Capital U.S. Aggregate Bond Index. I could easily invest my money in a strategy like this and come back in 20 or 30 years and be ahead of the game as long as there was no Nuclear Winter. Would I ever use this strategy? Maybe some day down the line, but right now I've got my mojo working on something more active. Stay tuned.