Opinion

Gregg Easterbrook

The next bubble: short selling

July 22, 2010

bubbles

Tech stocks drove off the cliff in 2000. Real estate went poof in 2007. Financial stocks melted down in 2008. So what’s the next bubble to burst? Short selling.

As we look back on three major market busts in a single decade, we have begun to idolize the shorts. Michael Lewis’ book, “The Big Short,” does exactly that. The New York Times just did so as well, lauding a shorts fund manager named Hugh Hendry, who says he wishes he could “short Obama.”

Practically everyone involved in capital markets now admires David Einhorn, who, in early 2008, warned that Lehman Brothers was dangerously leveraged. He was excoriated for saying so, and got the last laugh when his short-sales of the firm became lucrative.

Because shorts of the recent past look smart – and some became wealthy — it’s suddenly trendy to bet on decline. Investors now jumping into short selling — gambling that worrisome trends will continue — are making a move they should have made several years ago. This is exactly how bubbles form! Lots of people, recall, jumped into high-tech Internet stocks a couple years later than they should have, gambling on the notion that positive NASDAQ trends would continue.

According to figures compiled for this column by Lipper senior analyst Tom Roseen, from June to September of 2008, as the Dow and S&P were spiraling downward, a net of $10.7 billion flowed out of dedicated short bias funds. With a big fall in progress on Wall Street, that was the time to take profits on short positions. Since then, Roseen finds, a net of $26.9 billion has flowed into short funds.

True, $26.9 billion isn’t Lehman money – that company took $600 billion to Davey Jones’s locker when it hit the iceberg. But when billions of dollars flow into a specialized, very risky asset class, we have the makings of a bubble.

Shorts are assuming more bad news to come. What if economic news enters a cycle of steady improvement instead? (That’s what my book, Sonic Boom, supposes and there is considerable data to back the notion.) If we’re headed for years of steady, unspectacular economic improvement – shorting will be another bubble.

Which, of course, everyone will claim in retrospect to have known all along.

*****

Here are two other bubbles to watch for:

  1. Gold Prices:
    In adjusted dollars, gold prices have nearly trebled through the last decade. Gold prices collapsed in the early 1980s, and buyers lost their shirts. That can’t possibly happen twice, can it?
  2. Cupcake Prices:
    Also, cupcake prices are in for a major correction. Even in New York City and San Francisco, people seem unlikely to continue paying $5 for a cupcake that’s mainly icing, which, in turn, is mainly sugar. I’d unload Georgetown Cupcake now. Someday the cupcake bubble will be a standard b-school cautionary case study.
Comments
13 comments so far | RSS Comments RSS

If shorting is a bubble, it’s burst would be great news for most of America, for 2 reasons.

1. As I understand it, you can only short a stock if you have a buyer who thinks it’ll go up. So, by definition, half the people involved in a short bubble would be winners.

2. In order for a short bubble to pop fast be be “burst” instead of just deflating over time, the economy as a whole would have to improve as fast as it got bad. The idea that it could get better that fast, and that doing so would cause a “short bubble” to burst and have negative effects severe enough to care seems like a stretch.

Posted by drewbie | Report as abusive
 

A lot of people are piling into the market for books about financial crises. Are they too late?

Posted by Ian_Kemmish | Report as abusive
 

:) I have never heard an economic recovery to happen faster then the recess, i.e. a “short” burst is flowed by definition.

Posted by Ananke | Report as abusive
 

I couldn’t agree more. This is the time to read “Dow 30,000″ and not “Manias panis and crashes”!

Posted by Mario09 | Report as abusive
 

Gold has some uses, largely in electronics, but fundamentally gold is worth whatever you claim it is worth. After paying some fabulous price for the stuff you’d find it absolutely worthless if you couldn’t find someone still stupider to buy it from you. If you buy dollars and cannot sell them on you can go to the mall and convert your dollars to music videos. If you cannot sell your gold you must pay someone to cart it away. It is astonishing that people buy this stuff and that other people buy it from them afterwards.

Posted by bigturkey | Report as abusive
 

If the stock market is somehow manipulated from deep within the bowels (careful choice of word) of Wall Street, then popping the short selling bubble is a matter of (a) waiting until short positions are at an all-time high; and (b) pop the short selling bubble by Wall Street doing whatever they do to cause the DJIA to skyrocket. I’m no investment expert but let’s apply a simple test of logic: (a) short sellers lose money if the stock goes up; (b) if there are an unprecedented number of short sellers flooding the market, then the profit potential of the market going up is so powerful of a force that it actually drives the market up. I won’t pretend to understand how this might work, but the markets are a mathematical “engine” subject to the laws of physics. Just like “what goes up must come down” I suppose that “what goes down must come up” (like aiming one of those kids toys that shoot rubber balls down toward the surface of a marble floor).

Posted by DisgustedReader | Report as abusive
 

It’s a new world and gold prices are much more stable than the U.S. dollar. People are turning to gold for its stability.

Posted by CPA1976 | Report as abusive
 

I would like to see the day when you can not sell gold. Hahaha. Bigturkey, give me a break. Thousands of years of history and you still can’t understand the reality? Its worth what someone will pay for it, not what you say it’s worth.

Posted by CPA1976 | Report as abusive
 

Provocative, amusing and mostly ridiculous article.

Posted by yr2009 | Report as abusive
 

When people say “It’s a new world” and the old rules don’t matter, that’s exactly when the old rules start to matter!

Buy the assets that are out of favor, and prepare for the decline of gold.

Posted by MerrillGrinch | Report as abusive
 

Next bust is 22 year away.

I believe that short selling creat huge income for trading companies,Market downturn creat oppertunities for bears,Upturn creat wealth for bulls,and All rounder market make smart guy rich through both directions.The great news that will save market from terror is a death of professor and laden.They are both stand for terrorism,Both of them are getting very old and sooner or later they will die to spare the world.

If the law of physics stand for downturn why any market in the world will go up on first place?

Life exist only oneway from childhood to old man thus far every single child must go through the basic necessities of life.People who believe in cycles they must know the limit of waiting and available supply of resource.

Posted by satv | Report as abusive
 

gold, silver, paper money, stocks, out of favor assets, what should i buy? Or is it what should I trade. If the US dollar is an asset, is it “in favor”? Then should I trade it for something out of favor like Greek realestate or vintage Nash Ramblers? Today, for example Gold went up…or did it? In terms of Euro’s it went down. Is there a bubble in gold because nearly one percent of the US population has purchased it? Or is it because China is now the largest buyer of gold? Ah yes, the feared Chinese Bubble. Maybe I should short China.
Or maybe I should short the shorts. A song about short shorts has already been written, unfortunately. Another
missed opportunity.

Posted by 1bigrcm | Report as abusive
 

The next bust? the next bubble? Its already here — see the government stats on youtube — “meltup”. Its real. its now.

Posted by JJWest | Report as abusive
 

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