Originally published February 6, 2021
What Does Shorting the Market Mean?
You cant start a financial newsletter without talking about shorting GameStop. Non-investors are chatting this subject up all over and I find it difficult to explain to those people what shorting means as a concept. In the simplest terms, I would use the following example: It’s like borrowing your mom’s new sweater and selling it to your aunt for full price, with the idea that Walmart is going to eventually have a sale where you can then buy the exact same one back and return it to your mom. There, that’s all there is to it. You make a profit by keeping the difference between what you sell it for now and what you will pay for it in the future. You’re betting that the sweater is going to go down in price in the future (especially since it’s an ugly sweater).
The risk lies in the possibility that you’re wrong and that particular sweater could all of a sudden becomes a huge fashion hit and everyone will want one, causing a shortage where frenzied people are willingly pay lots of money for a chance to be seen in that ugly sweater. So now as the price of sweaters goes up, you’re on the hook to buy a more expensive sweater to return to your mom. In fact, if a craze of sweater buying gets out of hand (think cabbage patch dolls), you could be in for huge losses.
Shorting GameStop
So to add to our example and make it more like GameStop, imagine your sister finds out that you short-sold your mom’s sweater and she gangs up with her dumb friends and buys up all the sweaters at Walmart and single-handedly starts the fashion craze of bad pink sweaters. Now you’re panicking because there are no more sweaters available at the normal price and they are getting more expensive every hour. To make matters worse, all your friends who thought that shorting their mom’s pink fluffy sweater was a great financial decision are in the same boat, competing against you and driving up the price as well. In the end, it’s just a pink fluffy sweater worth whatever they are normally worth in the Walmart bin.
Like our pink sweater example, the GameStop situation is driven not by your sister but a group of retail investors (like us) who forced the squeeze using the social media platform Reddit. Oddly the entire Reddit movement is conceptually ill-informed because its premise is to get back at hedge funds who are perceived to take advantage of the little guy. The problem is that hedge funds, like most investors, have underperformed the market, just to a lesser extent. There is actually no reason to pick on them but that is the view nevertheless. In the end, most retail investors will likely lose money along with most of the hedge funds. A small minority will walk away with most of the money. As for real investors (not speculators as described above), this is purely gambling, stay away unless you are making a small bet knowing that you may lose most of your money.
Now that the GameStop discussion is over… ok it’s not. I took a speculative PUT option against GME. I am betting that GME will eventually go back to being just an ugly pink sweater. Small bet, high return if I am right…why not be part of history?
My Portfolio Changes
It appears that I have made lots of changes to the portfolio, sort of yes and sort of no. I would generalize that I have lowered the portfolio’s risk to become a bit more defensive by increasing international diversification and value positions. Ok here we go:
- I have added another ETF, a vanguard product (VSS) to the portfolio in order to continue my diversification into small-cap stocks. This one concentrates on following the FTSE small cap world index with the American companies removed. I already have the Russell 2000 ETF for American companies, so no point in double dipping on them. Strategy: In the long run, small caps perform better than the market and this is what I am trying to capture. Large caps have had a great run and if there is a rotation out of big caps, these will do well. I shied away from small caps in the past because they are historically volatile, but by using ETFs you can lower this risk.
- I bought Intel (INTC) as it has stumbled recently and is out of favour. It’s great for the long run, value-oriented, and defensive at these prices.
- I sold cognizant (CTSH) to fund the purchase of Intel. Cognizant is still a good company, but they missed their earnings for this quarter. Also, it’s done really well and might be overbought. Strategy: sell overbought stock and buy out of favour stocks… sounds like buy low sell high right?
- I bought Taiwan Semiconductor (TSM). It’s a competitor of intel, so if things do not go well with the above bet, TSM will benefit. It’s also an international bet.
- I sold SAP to fund the purchase of TSM, which I think is still a good European company but has been struggling recently. The swap is just a switch to quality.
- I bought Royal Dutch Shell (RDS.b) to replace COP. Essentially the European energy companies are moving towards cleaning their carbon emissions while the US companies are not. RDS.b is moving into natural gas. There does seem to be a move towards better energy management worldwide so I want to take advantage of that. RDS.b is also an international company.
I realize that downshifting to a more defensive position might lower returns a bit in the short run. My guess is that the market will continue to surge forwards for some time, but for how long? Who knows? There is definitely some exuberance out there and that is a bad sign. But there is also a huge pent-up demand to spend money, which will explode once things go back to normal. There is also lots of cash being printed, which is increasing the demand for stocks. It’s basically a tug of war and I really can’t tell where it will end up. There is a valid argument for both the bear and the bull.
Considering that the portfolio has achieved 29% in 2019 and 26% in 2020 a downshift is not a bad idea. The more the market continues in its exuberance, the more likely I will make additional defensive adjustments. Simply cashing out of an exuberant market is not prudent because no one can really time the market. This exuberance can go on for several years and that could be a bigger price to pay in forgone returns than a relatively smaller correction in the future.
Happy investing.
Marc’s Monthly Moves
| Buy | Sell |
| Buy Vanguard world small cap less USA, symbol (VSS) Buy Intel (INTC) Buy Taiwan Semi Conductor (TSM) Buy Royal Dutch Shell (RDS.B) Buy GameStop (GME) put option | Sell Cognizant (CTSH) Sell Conoco Phillips (COP) Sell SAP (SAP) |
Marc’s Portfolio YTD Performance
- Portfolio return 3.17% (Including currency losses/gains)
- Portfolio return 3.0% (without currency losses/gains)
- SP 500 return 3.48%
Portfolio loss against SP500 -0.48 points.
Money with Marc 