Investors who were basking in the early summer glow of a stockmarket heat wave would be forgiven for feeling mixed emotions about the recent cooling in equity prices. The FTSE All-Share completed an impressive 1-year gain of 30% when it tipped over 3,600 points in May but it’s now more than 7% off that high, leaving many wondering whether a deeper correction is unfolding. While the recent falls are a tonic for market-watchers concerned about unsustainable rises the current conditions perhaps warrant a closer look at portfolio positions to ensure they aren’t harbouring expensive stocks that now look decidedly risky.
Timing a sell decision
We have written at length about the difficulties of deciding when to sell shares and why investors focused on technical and fundamental indicators often see things differently. As part of that decision making process – and after 12 months of strong gains – now is the time to put your shares through a mid-year financial work-out to figure out whether their original appeal still exists. Finding out which if any of them are beginning to look overly expensive against their fundamentals could be an indicator of those that are needlessly exposed to further stock market falls. One way of doing that is to use some smart money criteria that are more commonly associated with short selling.
Back in May 2008, James Montier, the respected GMO analyst (then at Societe Generale) put the case for shorting stocks in a research note called Joining The Dark Side: Pirates, Spies and Short Sellers. At the time the economic backdrop was offering a dearth of equity buying opportunities so he began developing investment strategies that picked out expensive looking, low quality companies – the ones whose share prices were very likely to fall.
“It never ceases to amaze me that whenever a major corporate declines the short sellers are suddenly painted as financial equivalents of psychopaths. This is madness, rather than examining the exceptionally poor (and sometimes criminal) decisions that the corporate itself took, the short sellers are hauled over the coals.” James Montier
Borrowing ideas from the dark side
Montier found that it was profitable to systematically sell stocks looking vulnerable due to a fingerprint of high valuation, low financial strength and management excess. For valuation, Montier picked on a metric with a mixed reputation: the price to…
