Wednesday, June 25, 2008

Blue chips looking more like cow chips to investors

11:29 PM, June 20, 2008

Big, blue-chip stocks are supposed to be a good place to hide out in a dicey market.

Not this time.

In Friday’s brutal Wall Street sell-off, the Dow Jones industrial average and Standard & Poor’s 500 index both suffered bigger percentage declines than indexes of smaller stocks -- continuing the trend of the last seven weeks.

The Dow dropped 220.40 points, or 1.8%, to 11,842.69. That left it just 0.9% above its 2008 closing low of 11,740.15 reached on March 10.

The Russell 2,000 small-stock index, by contrast, lost 12.10 points, or 1.6%, to 725.73. And it’s still 12.7% above its 2008 low, also reached on March 10.

"Something is wrong with this picture," says Brian Gendreau, investment strategist at ING Investment Management in New York. "Small-cap issues are supposed to be riskier."

In other words, if investors are seriously worried about the economy falling into a painful recession because of record oil prices, a badly wounded banking system and a spent-out U.S. consumer, they ought to find more comfort hanging out in bigger stocks than in taking a chance on smaller names.

Yet smaller issues outperformed the bigs in May, and the same is true so far this month.

Why are blue chips bearing the brunt of the damage in this market relapse?

Shortsalesthroughjune_2 Here are two possible explanations:

--Nervous institutional investors are in a hurry to raise cash, and when you’re in a hurry you sell your most liquid stocks. You always know you’ll find someone to buy your General Electric Co. shares, and at a price relatively close to where the stock is in the market at that moment.

But selling a small-company stock in a falling market is a much more difficult prospect, particularly if you’re trying to sell a lot of shares at once. You risk triggering a devastating price decline.

--Bearish investors who expect the market to continue sliding are targeting blue chips for "short" sales, because they’re the easiest stocks to short. In a short sale an investor borrows stock from a brokerage and sells it, betting that the market price will fall. The idea is to repay the loaned shares later with stock bought at a lower price.

If the trade works out, you pocket the difference between the sale price and the repurchase price.

Michael Holland, head of investment firm Holland & Co. in New York, notes that big-name stocks’ liquidity makes them a breeze to borrow for short sales. The number of shorted shares has risen sharply since mid-April in such Dow-index stocks as American Express, General Motors and GE.

The total number of shorted shares of New York Stock Exchange-listed companies rose to a record 17.65 billion shares as of June 13 from 16.43 billion as of May 30, a 7.4% jump in just two weeks. Clearly, the bears are running wild.

Holland, an optimist, points out that heavy short-selling can be a bullish sign. If the market turns up the shorts could suddenly be in the red with their trades, and could rush in to cover them. Their buying could add fuel to any rally.

He thinks the market sell-off has entered "the throw-up stage," and once in that stage, he says, "beware being short!"

But I pointed out to Holland that, although there was some short covering in late March as the market rebounded, the total of NYSE shorted shares didn’t decline much. And by mid-April it was rising again.

That shows there are some very bearish -- and determined -- short sellers out there. Scaring them out of their positions may not be easy.


Comments:

I second Holland's motion in a manner of speaking. With the carnage that we saw last week in the markets, stock will bounce up in the near term. So for those shorts that weren't smart enough to take profits when the DOW dropped 220 points in one day, there will be some frantic short covering next week.

If you're going to be a bear...be a grizzly. Forget shorting Blue Chips, short the indexes.

Sam:

Its obvious you are long and WANT a bounce...which is OK and understandable. But it goes against some basic trading principles. One of the most common mistakes traders make is getting out of a profitable trade too early..the converse mistake is staying with a loser too long. The proper strategy with a big winner is to stop it at a point outside a range that could reasonably expected to be volatility limits...and stick with the trend..your 'friend', as is said. Further, Sam, you're not facing reality...another typical failing of traders. Does not a record short # tell you that the bears are getting control of the market? Short sellers, as a rule, are not John Q Public, they are pros...and what little percent of market trading is done by individual investor/traders is, nonetheless, huge compared to the percent of the average, individual, investors' short selling. My point is this: large short sellers are smarter than you think they are and minor, short term bullish factors may precipitate a short covering rally that, in the longer run, affords greater profit opportunities...on the short side. Please, when you decide to be net or naked short in this market..let us know..I, for one, will fade you.


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