History schmistory....

If you thought January was bad for stocks, wait for February, was the title of the CNBC.com, February 3rd, 2014 article. Here's a snippet: 

February is historically a rocky month for stocks, but it's bound to perform even worse when January is negative.

Since 1971, when January was negative, the S&P 500 extended its losses into February 72 percent of the time, falling on average 2.4 percent. That ratio stands at 65 percent for the Dow and 57 percent for the Nasdaq.

Well, so much for history being your guide. Not only did the S&P 500 not fall 2.4 percent in February, it rose 3.74%. The NASDAQ gained 5.13 percent.

I don't suppose regular readers need me to repeat, for the thousandth time, my you-can't-time-the-market mantra. So I shan't. I'll just warn any short-term investors who may have stumbled onto my blog to try and not get carried away by reports suggesting that there's good times in store for March and April. Like Springing to life? In last 20 years, stocks’ largest gains came in March, April, posted in Wednesday's online edition of the Wall Street Journal. Here's a snippet: 

March and April have been the S&P 500’s two best months over the past two decades, says Ryan Detrick, senior technical strategist at Schaeffer’s Investment Research.

March and April on average have delivered returns of 1.52% and 2.19%, respectively, topping all other months.

So, does my warning to short-timers mean I'm predicting something other than the usual March/April gains? Not at all. Although that is clearly what many "sophisticated" short-timers are indeed expecting.

There's this stat they call "short interest", it's the percentage of a company's outstanding shares that have been sold short. Short-selling is the practice of borrowing, through an intermediary, someone else's shares of stock, and immediately selling them. Of course the borrower has to eventually return what he borrowed, meaning he'll have to buy them back and return them to their rightful owner. Why would someone do such a thing? Because he believes the shares he borrowed are going to plummet in price. If he's right, he'll wait till he thinks the shares are somewhere near as cheap as they're going to get, buy them, give them back to the lender and pocket the difference.

Example: short-seller (SS) borrows 100 shares of ABC and sells them for $100 per share (for $10,000). ABC drops to $50, SS buys them back for $5,000, returns them and pockets a cool $5,000.

Back to "short interest": It was on the rise the beginning of February. Those "sophisticated" short-timers were no doubt figuring that 72% odds of a February decline was something worth betting on. And, interestingly, they remain undeterred as we enter March. In fact, presently, short interest for the stocks comprising the S&P 500 Index is at a 52 week high---so now they're betting against history's bullish case for March and April. Hmm... So should we be short-term worried? I mean they are "sophisticated".

Well, yeah, short-term I'd say we're way overdue for a correction (that's 10-20% down), but the rise in short interest doesn't, in my view, in anyway suggest it'll happen in March or April. In fact, it kinda suggests not (don't hold me to that). You see, a rise in short interest is essentially a rise in pessimism. And pessimism is generally a good thing for a bull market, in that it means that there's lots of folks who've yet to join the party. Party's go longer when new guests keep showing up. It's when everybody's arrived that you know the end is near. I mean you can't party forever.

Plus, you should see what happens when short-sellers capitulate. In fact, you've already seen it a number of times over the past 5 years. It's those days when, out of the blue, the Dow jumps like 300 points. Those are (can be) what they call "short-covering rallies".

It goes like this: SS borrows 100 shares of ABC and sells them for $100 per share (for $10,000). ABC rises to $125, SS panics and buys them back for $12,500 and returns them, depocketing a not cool $2,500. He bought them back because he was afraid of losing everything he's got if ABC turns into Google and goes to $1,200 per share. Imagine what the market does when lots of SS's have to cover their short positions (buy stocks like mad) --- yep, it goes up bigtime.

So why do I bother you with all this short-term stuff? Just giving you a little insight into what (and why) to maybe expect over the coming weeks. Whether it comes by way of short-covering rallies, margin call selling (kinda the opposite of short-covering), overdue corrections or the next bear market, the one thing I will predict for 2014 is a lot more volatility than we saw in 2013.

Thank goodness you’re neither a frustrated short-seller nor a heavy-duty partier. You’re a long-term investor who understands that all things are cyclical, that no one can consistently time the ups and downs, that a diversified portfolio is essential to investment success (and personal sanity), and who looks to enjoy—for years and years to come—the goods and services provided by the global companies whose stocks occupy that all-important long-term, growth-oriented, portion of your portfolio. Sound familiar?