Posted on: Friday, February 18, 2005
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Bear Funds Lick Chops
By Gregg Staff Reporter

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Short-selling funds are ready to come out of hibernation.
Bear funds have had a rough run the past two years, as their strategy of betting against stocks has put them on the wrong side of a solid bull market. After enjoying significant profits following the collapse of the tech bubble, bear funds gave back much of their gains in 2003 and 2004 as the S&P 500 rose 29% and 11%, respectively.

Since swooning in January, the broad index has battled back to the flat line for 2005. That move has certainly emboldened bulls who were briefly worried by the old saw that a down January inevitably precedes a down year for stocks.

Nevertheless, managers of short funds are feeling optimistic as well. Some say the market's rally the last two years has driven up low-quality speculative stocks whose gains can't last.

For instance, Charles Zender's $41 million, quantitatively driven Grizzly Short fund has risen 3.3% this year. While it's far from unheard of for a quant fund to beat its benchmark, the fund's gains could serve as a bearish indicator in their own right.

Instead of poring over a company's financial statements the way most short-sellers do, Zender employs what he calls a vulnerability index. It measures 13 quantitative factors that could cause a stock to sink, including high short interest ratios and heavy insider sales.

Zender refused to name any stocks being flagged by his model. He does say his fund is "more diverse in terms of sectors than at any point in recent memory," which he sees as evidence that the market is ready to stumble.

"Instead of finding pockets of weakness like semiconductors or health care," says Zender, "we are seeing opportunities opening up across the board."

Charles Minter, co-portfolio manager for the $71 million Comstock Capital Value fund, agrees that 2005 is shaping up as a good one for short-sellers. Comstock is a bear fund that selects its targets based on macro-economic forecasts coupled with individual stock valuations. Minter remains optimistic even though his fund is down 3.2% this year.

"We were wrong in 2004 in that we thought it looked a lot like 2000," says Minter, who writes off last year's gains as a cyclical rally in a secular bear market. "Basically, they were both election years which followed a financial mania that saw the lowest-quality stocks rally to unsustainable levels."

Minter is confident that 2005 will be the negative year that 2004 was supposed to be, at least in the eyes of market skeptics. To bolster his case, he points to the lack of what he calls a complete capitulation following the late-1990s bull run.

"One of the hallmarks of a secular market bottom is widespread public fear, disillusion and disgust with the market followed by a long period of outright apathy," says Minter. "This certainly did not happen in October 2002, as strong public participation in the market has come back rapidly."

Minter's proof that the public has jumped back into stocks far too quickly for its own good comes in the form of a January report from the Investment Company Institute. The data say stock fund assets reached $4.4 trillion at the end of 2004 -- a figure that is not far off the $4.6 trillion peak in August of 2000, just after the bull market peaked that spring.

Minter would not comment on individual short positions, but among the names listed on the fund's third-quarter report to shareholders are the Nasdaq 100 Index (QQQQ:Nasdaq - commentary - research), Dell (DELL:Nasdaq - commentary - research), Intel (INTC:Nasdaq - commentary - research), Ryland Group (RYL:NYSE - commentary - research) and International Paper (IP:NYSE - commentary - research).

David Tice, portfolio manager of the $393 million Prudent Bear fund, the largest of all actively managed bear funds, says the market has been "just treading water" ahead of what he thinks will surely be a downturn in 2005.

Tice's fund looks at a mix of micro and macro factors including valuation imbalances, balance sheets and currency strength. Prudent Bear also holds a small long position in gold stocks, which helped curb losses during the bull markets of the past two years. Prudent Bear is off 1.87% this year."The next few quarters will disappoint, especially in the high-beta tech names, primarily because there are no good reasons for people to go out and buy electronics anymore," says Tice. "Inventories and capacity are still very high and pricing power remains weaker than ever."

Like Zender and Minter, Tice wouldn't name his current crop of short candidates. However, the well-known short-seller did note Applied Materials' (AMAT:Nasdaq - commentary - research) recent warning as evidence that the chip group is poised for a fall.

"Semis have made a huge comeback over the past three weeks, so it's going to be tough to drive them higher without a good reason," says Tice, who is, of course, short the group.

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