Different Mind Set

Shorting takes a bit of a mental adjustment because most people are used to thinking only in terms of things that go up. You can watch CNBC all day long and hear only one or two fleeting references to shorting. And if you ask the typical financial advisor for ideas, he'll go on for hours about what's likely to rise but will be stumped by a request for short candidates. This institutional blind spot ignores half the market, sometimes by far the better half. In 2006, for instance, a typical financial planner or stockbroker would have probably recommended a list of long positions that looked something like this:

• Cash: 10 percent of total capital

• High-grade bond fund: 20 percent

• Commodities fund: 10 percent

• Russell 2000 stock fund: 20 percent

• Global stock fund: 10 percent

But someone who recognized the massive financial imbalances building up in the housing, consumer finance, and foreign exchange markets—and who was comfortable doing something about it—might have constructed a portfolio of the following short positions:

• Merrill Lynch

• Lehman Brothers

• Countrywide Credit

Table 21.1 shows how the two portfolios performed.

Clearly, it was better to be short bank and homebuilder stocks than to be long a traditional diversified portfolio. And just in case you suspect that 20/20 hindsight made it possible to cherry-pick the biggest losers, note that our short list excludes Bear Stearns, Ambac, and MBIA, big-name financial stocks that lost an average of about 80 percent between 2006 and 2008—and were obvious short candidates at the height of the housing bubble. Dozens of other homebuilders and banks did nearly as badly, while most subprime mortgage lenders went bankrupt. So the short list presented here is actually conservative, in the sense that it's composed of companies that survived. That may not be true by the time you read this, however, since Lehman Brothers and Merrill Lynch were looking very shaky in mid-2008. The lesson: Just as there 's always a bull market somewhere, there 's

Table 21.1 Long and Short Portfolios

Long Portfolio

Cumulative Return (percent), 1/1/06-12/31/07*

Short Portfolio

Cumulative Return (percent), 1/1/06-12/31/07**

Beazer

Cash: 10% of total

6

Homes (BZH)

90

High-grade bond

fund: 20%

24

Citigroup (C)

35

S&P 500 stock

Countrywide

fund: 30%

17

Credit (CFC)

72

Commodities

fund: 10%

41

KB Homes (KBH)

69

Russell 2000 stock

Lehman

fund: 20%

9

Brothers (LEH)

(5)

Global stock

Merrill Lynch

fund: 10%

35

(MER)

20

Total Return

20

Total Return

47

*The long portfolio's total return is the weighted average of its components. Returns for individual components are derived from leading funds in those sectors.

**With a short portfolio, return refers to the decline in price of shorted stocks. A negative return (the result of a shorted stock going up) is denoted in parentheses. Dividends are assumed for the sake of simplicity to average 2% per year and are subtracted from the short portfolio's return.

*The long portfolio's total return is the weighted average of its components. Returns for individual components are derived from leading funds in those sectors.

**With a short portfolio, return refers to the decline in price of shorted stocks. A negative return (the result of a shorted stock going up) is denoted in parentheses. Dividends are assumed for the sake of simplicity to average 2% per year and are subtracted from the short portfolio's return.

also always a bear market, frequently caused by the same forces driving the bull market. In tomorrow's world, the conditions and trends that will allow clean tech to thrive will devastate other industries, giving you a chance to make money in both directions. Let 's consider some likely short candidates.

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Lessons From The Intelligent Investor

Lessons From The Intelligent Investor

If you're like a lot of people watching the recession unfold, you have likely started to look at your finances under a microscope. Perhaps you have started saving the annual savings rate by people has started to recover a bit.

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