40% of stocks lose value in an average year

Doug Kass, who sells stocks short for a living, and Merrill Lynch, a leading stock broker, agree that in an average year, some 40% of the stocks in the Standard & Poor’s 500 go down. Historically, stock pickers have operated under the assumption that only 5% of those stocks declined in an average year, according to the MotleyFool.com.

In an already famous interview published in the May 19, 2008, Barron’s, Kass outlined his strategy for selling stocks that he thought he could buy back at lower prices. And one of his major points was that, “In the past two decades of the bull market, on average about 58% of the issues on the New York Stock Exchange have advanced and roughly 42% have declined every year. The 42% provides us with fertile opportunities for secular, cyclical and thematic shorts. Short selling is the least served and most uncrowded hedge-fund strategy out there.”

Kass is president of Seabreeze Partners Management,  which is a hedge fund. Barron’s reports, “As of April 30, flagship Seabreeze Partners Short fund was up 16.5%, excluding fees, versus a 5.6% loss for the S&P 500. Since inception in January 2005, the fund is up 40.7%, versus a 15% gain for the S&P.”

But shorting stocks is a dangerous game, and few institutions or individual speculators play it. Kass outlined some of the rules he follows when shorting stocks. They’re interesting but relatively irrelevant for most investors.

What is important for the average investor is to have a feel for the stocks that are being shorted or are likely to be sold short and to not own those stocks. If you own a stock that has a high or growing short interest, sell it. If you don’t own it, don’t buy it.

How do you know if a stock’s being shorted?

It’s not easy. You have to be a stock market and economic news junky so you can see evolving trends.

What’s the big news today? Falling home prices, rising inflation and surveys that show consumers are expecting the worse and worrying about their rising credit card debts.

For Kass, that means consumer goods makers are in trouble. Not only are their customers on a buying strike, but their material costs and distribution costs are soaring with no relief in sight.

Look at a stock’s charts. If a stock has bearish daily, weekly, monthly and point and figure charts, sell it and don’t buy it. However, you probably won’t want to short it, given the risks involved. But, as shown below, the charts aren’t always good indicators of which stocks are being shorted.

Look like for articles that quote money managers and analysts who are shorting stocks or advising that stocks be shorted.

In the Barron’s article, for example, Kass names several stocks he’s shorting. As a result, even though others may be buying the stocks, I wouldn’t buy them unless I had good reasons to disagree with somebody like Kass.

The stocks he is shorting include consumer goods makers such as Colgate-Palmolive (CL), Kellog (K) and General Mills (GIS). Their daily charts are here. Click on a chart to seek weekly and point and figure charts. Two of the three stocks, K and GIS, actually have bullish price objectives, which aren’t predictions. Only the CL point and figure chart shows a bearish price objective.

Thus, Kass is fighting the tape, confident that his assessment of the current economic situation will prove him correct and give him handsome profits sooner than later.

What Barron’s doesn’t ask and he doesn’t reveal is how he manages his money. How big do his losses on a trade have to be before he cuts his losses by buying a stock back? How long does he hold a position, on average, before he takes his profits?

What Kass says is that he works hard to limit his risks by devoting no more than 2.5% of his portfolio to a single position or more than 20% to a single sector. And he doesn’t short stocks that others appear to be shorting. He looks for stocks with low short interest numbers, which you can find under “key statistics” on Yahoo.com. Finally, he’s short or long 35 to 40 holdings.

Kass is an experienced analyst and has a strong research team behind him. No individuals can match those resources, and few hedge fund managers have his experience in buying and shorting stocks.

Shorting stocks works for him, but I’m not sure it would work for me.

Full disclosure: I don’t have positions in any of the stocks mentioned above or in the Barron’s article.

For educational purposes only. Investigate stocks on Reuters.com, Yahoo.com and Google.com. Also, search the web for information. And read your local papers, which cover companies based in your state and area as well as anyone. That gives local investors an edge, if they know what to look for.

 

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