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Short and Ugly


The stock market has continued to be a difficult environment for short sellers. Short dedicated hedge funds experienced the worst year since at least 1994. The CSFB/Tremont Dedicated Short Selling Hedge Fund Index lost 32.6% in 2003. The previous worse year was 1999 when the index lost 14.2%. It is also important to remember that while the funds are described as dedicated short fund, most have are long and short with the overall exposure being net short. Last week, Rocker Partners, one of the best known short sellers was mentioned in the Wall Street Journal, Short-Seller Rocker Partners Was Mauled by Bull Market. Using the numbers reported along with some 9th grade algebra, it appears the fund was positioned about 140% short and 90% long or 50% net short. It wouldn't be a surprise if this was close to normal exposure for a significant portion of the short selling funds. After experiencing the worse year in at least ten years, 2004 has not eased the pain. Heavily shorted stocks have continued to outperform the general market. CSFB calculated that the short interest weighted NASDAQ 100 outperformed the cap-weighted index by almost 100 basis points in January. Some of the more popular short stocks have wrecked havoc on investors that have been short. Taser International has been one of the most talked about names lately. It has 3.7 million shares sold short, while its publicly traded float is only 5.6 million shares. The stock is already up 81% year-to-date and over the past year the stock is up over 3500%. Netflix and Research in Motion are two other stocks that are heavily shorted and have had impressive gains this year and last year.

Another facet of the market that has added complexity is the surge in mergers and acquisitions. Wednesday's announcement from Comcast saying that it is offering $66 billion for Disney was the biggest deal announced this year, eclipsing JP Morgan's $55 billion acquisition of Bank One. There has been about $175 billion worth of acquisitions announced year-to-date. This is more than has been done during the entire first quarter of 2001 or 2002. It is also more than done in the first two months of 2001. In, fact the total amount of announced acquisitions so far this year is over 30% of all the acquisitions which were announced in each of the previous two years. The main reason that companies have started acquisitions is that companies have gotten their cheap currency back - high stock prices.

Speaking of hedge funds, selling volatility was one of the most popular trades by hedge funds last year. Now that volatilities have fallen to levels not seen since 1996, traders have been reevaluating whether to maintain this trade or possibly reverse sides and go long. The question traders are asking is whether volatilities are low relative to just the bubble years and will decline further to levels reminiscent of the early and mid-1999s, or will volatility reverse and head to where it typically was during the past six or seven years. On the surface the idea that volatility soared during the bubble years and will now revert back to pre-bubble levels appears compelling. Given how we see the current economic and financial landscape, we would argue that volatilities are poised to increase in the future. The Chicago Board Options Exchange is launching a futures exchange. The first product to trade on the new exchange will be a contract on volatility. For those that are interested, here is a link to the webpage announcing the product, CBOE Futures Exchange & Volatility Index Futures

Of course the growing economy is the main reason the market has increased over the past ten months. Advertising has been one of the lagging industries since the economy rebounded. As companies started realizing higher business activity, advertising started picking up. This seems to have occurred around September and continued to pick up during the fourth quarter. Last week, Gannett reported that fourth quarter advertising revenue increased 10% from the previous year. So far the momentum has continued into 2004. According to Magazines Publishers of America, magazine ad spending increased 10.4% in January, which was the fastest pace since May 2003 when it rose 12%. The strongest categories were Transportation, Hotel & Resorts (+33.0%), Apparel & Accessories (+24.2%), and Drugs & Remedies (+22.0%). Two categories experienced declines, Technology (-17.2%) and Financial, Insurance & Real Estate (-6.2%).

The travel sector has also been a lagging industry. The recent increase in advertising by the travel industry as indicated above reveals that this area of the economy is starting to get more optimistic. Total ad spending by the industry fell 3% last year, so the comparisons are relatively easy. But the industry is still spending more than last year. And according to some of the hotel companies, activity has started to pick up. Last week, Starwood Hotels & Resorts, operates the Westin, Sheraton, St. Regis and W brands among others, beat analysts estimates. Furthermore, it reported that January RevPAR (Revenue Per Available Room) increased 6.6% in North American and 8.4% worldwide. Results have accelerated since the forth quarter. During the fourth quarter, North American and worldwide RevPAR increased 4.7% and 6.6% respectively. The hotelier said that the recovery was "led by the significant improvement in transient demand, which is up more than 11% in North America for the quarter compared to the 4th quarter of 2002." Additionally, Starwood expects RevPAR to increase 5% to 6% in the first quarter. Marriott's results were not as impressive. It said that fourth quarter RevPAR was flat with the year ago period. It did say, however, that Ritz-Carlton experienced a 4.8% increase. This is similar to what Starwood reported and provides more evidence that luxury has been performing better than the mid-priced and discount items.

During his testimony to Congress on Wednesday, Greenspan hinted that the Federal Funds Rate would remain at 1% for quite a while. Additionally, Greenspan said that he thinks the establishment survey produced by the Bureau of Labor provides a better gauge of the employment situation than the household survey. The markets seems to key off this reiteration (Greenspan has said before that he prefers the establishment survey), the S&P 500 added six points in a matter of minutes following this comment. The household survey has been reporting a much stronger labor market than what the establishment survey has reported. In January, establishment survey reported that nonfarm payrolls increased by 112,000 in January. According to the household survey, there were 496,000 jobs added in January. Over the past year the household survey shows that almost one million jobs have been created. This compares quite favorable versus the 35,000 jobs lost that the establishment survey calculates. This has been a big focus for debate recently. By Greenspan acknowledging his preference for the establishment survey, he further signaled that he believed the economy was still suffering from some weakness and was less in a hurry to begin tightening monetary policy.

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