In this article titled – Steer Clear of the Short Side, Mohnish Pabrai argues against short positions as a hedge, suggesting a long-only unleveraged portfolio as a better alternative. With over 100,000 publicly traded stocks, it’s possible to hedge against various macroeconomic factors without using derivatives.
Pabrai highlights the risks of short squeezes, where heavily shorted stocks experience rapid price increases, causing panic among short sellers. He concludes by likening shorting stocks to attempting unnecessarily challenging tasks, quoting Warren Buffett’s philosophy of choosing easier and more straightforward investment strategies.
Here’s an excerpt for the article:
Having some short positions as a hedge is considered acceptable investment philosophy, but I disagree for all the aforementioned reasons. With over 100,000 publicly traded stocks worldwide, you could hedge virtually any scenerio in a long-only unleveraged portfolio with no derivatives. Every business reacts differently to macro factors. Some do well in recessions, while others prosper when the dollar is strong. Still others benefit from rising interest rates. So why not create a portfolio that is likely to weather most storms well and still keep the 8% to 10% house advantage on your side?
If you still remain unconvinced, then let’s delve into the mechanics of a short squeeze, which is truly a sight to behold. Capitalism has a few other things to offer that are as entertaining as witnessing a short squeeze.
Some of the most heavily shorted stocks have short interest ratios higher than 50. That is, based on average daily volume, it would take 50 or more days for the shorts to exit their positions. If a heavily shorted stock sees it stock price rise, then some shorts start wanting to close out their positions. This means they have to buy back the stock. As they buy shares, the stock rises further, which causes panic among the remaining shorts who also now want to close out positions.
You get the picture. The door isn’t big enough, and pretty soon there’s a stampede happening as the stock price soars, causing more short-covering panic and more buying pressure.
I should correct myself: A short squeeze is only entertaining if you’re watching from the sidelines.
To sum up, as Buffett says, why try to jump over 7-foot hurdles when you can walk over 1 foot bars? Shorting stocks is simply a sucker’s bet.
You can read the entire article here:
Steer Clear of The Short Side – Mohnish Pabrai
For all the latest news and podcasts, join our free newsletter here.
Don’t forget to check out our FREE Large Cap 1000 – Stock Screener, here at The Acquirer’s Multiple:
