What to Short When the Rally Dies

Apr. 17, 2009 10:16 AM ETSRS, FAZ, SH, PSQ, DOG95 Comments
Todd Sullivan profile picture
Todd Sullivan

I have been droning on for what seems an eternity (a few weeks) that I feel this market rally is just overdone and due for a fall. I still feel that way, but am getting to the point where I am going to put some money where my mouth is.

Now, don't get me wrong. I have been very happy to be wrong for the last month as the rally has been very good to me. Core large long holdings like Dow Chemical (DOW) (which I significantly added to at $6.80 in March and again at $9 in early April), AutoNation (AN), Sears Holdings (SHLD) and Wells Fargo (WFC) have all seen tremendous share price increases of at least 50% since the March lows (I am still down 10% in Wells Fargo overall though). This makes up for the gut-wrenching carnage in January and February, though Sears and AutoNation are up 50% and 60% YTD respectively.

Even Borders (BGP) has finally shown signs of life, almost tripling in a few weeks (still down 40% in this small position).

That said, I cannot escape the fact that the economic fundamentals of the economy do not warrant the general market rally we have seen. It is also possibly true that the drop we saw early this year was overdone, meaning part of this rally is simply correcting an overreaction to the downside in March. I am hesitant to fully buy into that though.

There are over 6 million folks without jobs now, the housing industry is simply in shambles and getting worse, foreclosures are surging, Q1 GDP is decidedly negative and Q2 looks only marginally - if any - better. Commercial Real Estate is the next time bomb to drop on banks and that fuse is only just beginning to burn, and the Federal Reserve is just about all out of ammo unless they want to start paying people to borrow. In short, not too much to be optimistic about.

Do I short CRE with the SRS ETF? Not for me. REITs are already on death's doorstep, so buying in there might be a bit like going hunting and shooting a deer caught on a trap - not very satisfying or meaningful.

Short financials with FAZ? Not too sure about that one either. While the rally there has been spectacular and unwarranted, it has become clear that the US Government will stop at nothing, including changing accounting rules, bogus "stress tests" and more capital infusions to make sure the banks are propped up. That said, I am hesitant to bet against the guy with the ability to change the rules of the game on a whim to make sure he wins.

Short the dollar with UDN? Now, while the dollar may be headed for devaluation because of massive Treasury actions, when compared to many other currencies, it may actually gain in value. It's perverse. In fact, since December that is what has happened. Being "less bad" than the other guy isn't really a reason to invest.

I think the safest way to so it is the simple SH Short S&P ETF, PSQ to short the Nasdaq or DOG to short the DOW. It tracks to daily price fluctuation of the overall index without exposing the holder to the negative returns of the leveraged ETFs. The 3X ETFs are only good for short term trades and the volatility will scare most folks. That and the downside pain is fast and furious and the longer you hold them, any downside you experience exceeds any upside you see later unless it is dramatic.

These can protect you from a market sell-off and unlike the leveraged ETFs, not hurt you bad should the market continue to rally (which it can, markets are not rational by any means). I like the SH the best of the lot. Should I go into it, the position will not be all too large, just enough to take the bite out of what I think is the upcoming sell-off.

Here is a good list of ETFs.

Disclosure ("none" means no position): Long Stocks listed, none in ETFs

This article was written by

Todd Sullivan profile picture
Todd Sullivan is a Massachusetts-based value investor and Co-Founder and General Partner in Rand Strategic Partners. He looks for investments he believes are selling for a discount to their intrinsic value given their current situation and future prospects. He holds them until that value is realized or the fundamentals change in a way that no longer supports his original thesis. His blog features his various ideas and general commentary and he updates readers on their progress in a timely fashion. His commentary has been seen in the online versions of the Wall St. Journal, New York Times, CNN Money, Business Week, Crain's NY and others. He has also appeared on Fox Business News and is a RealMoney.com contributor. He has twice presented at Bill Ackman's Harbor investment Conference and is a regular presenter at the Manual of Ideas "Best Ideas" conferences. Visit his sites: ValuePlays (http://valueplays.net/) , Rand Strategic Partners (http://randstrategicpartners.com)

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