Having been a child of the 90s, my formative investment years were marked by a stock bull market bubble in the late 90s, a blowup in the early 2000s, a subsequent recovery, and then the Great Financial Crisis (GFC) of 2008. As an investment analyst, I subsequently became borderline obsessed with long/short[i] investing. It just made sense to me. Based on my experiences, with no real math or stats behind the “feeling”, there was more than one way to make money in stocks, not just from the price going up but also from the price going down.

Enter Sarbanes-Oxley Act (2002)[ii] and Fed Policy in the GFC, among other things, and the last two decades have challenged those “feelings” of even the most ardent of short sellers. The graph below shows that short interest[iii] is at levels not seen since the late 90s.

Further, in the graph below, the number of professional investors that try to make money from stocks going down has declined significantly amidst bad performance.

Fed Policy, that of easy money that tends to buoy all asset prices, is not the only culprit. The advent of faster and faster technology, the increased attempt to even the playing field for all investors with fair distribution of information, tighter auditing and corporate governance, increased transparency, and more investors looking at investment opportunities out there, all contribute to the challenge of short selling. The list actually goes on from here as well. Let us just say, shorting has always been hard, and it seemingly has gotten harder.

So, what are investors to do? Well, you can choose not to short and be long only which will most likely serve you well over time, albeit with some wild rides along the way, or you can short but very selectively and with great due diligence and weight the strategy according to your skill set and goals. Or you can look for other ways to diversify the risk of a long-only portfolio. At Members’ Wealth, where appropriate, we still seek to utilize all tools, in the right size, to try to help our families reach their goals within their risk tolerance. Higher stock prices and valuations, combined with the lack of interest in shorting has us working overtime looking for the opportunities others may be missing. If you are unclear if your portfolio utilizes short selling, or if you want to learn more, please reach out to your advisor.

[i] Long/short investing is a strategy where you buy stocks you believe will go up (going "long") and sell stocks you think will go down (going "short"). This way, you can try to make money whether the market is going up or down.

Short selling is when someone borrows stocks and sells them, hoping to buy them back later at a lower price, so they can return the borrowed stocks and keep the difference as profit. It's like selling something you don't own yet, planning to buy it later for less money.

[ii] The Sarbanes-Oxley Act (SOX) is a U.S. federal law enacted in 2002 to protect investors from fraudulent financial reporting by corporations. It was established in response to major corporate scandals such as Enron and WorldCom, and it aims to improve the accuracy and reliability of corporate disclosures.

Sarbanes-Oxley impacted short investing primarily by increasing transparency and accountability in financial reporting. Some specific effects include:

1. Enhanced Financial Disclosures: Companies must provide more detailed and accurate financial statements, making it harder for short sellers to profit from misleading or false information.
2. Increased Compliance Costs: Companies face higher costs to comply with SOX regulations, which can impact their financial performance and potentially influence short selling strategies.
3. Improved Corporate Governance: Stronger internal controls and audit procedures reduce the likelihood of fraud, making markets more stable and potentially affecting the volatility that short sellers often exploit.

[iii] Short interest as a percentage of market cap is a way to measure how much of a company's stock is being shorted compared to its total value. It's calculated by dividing the total number of shorted shares by the company's market capitalization and then multiplying by 100 to get a percentage.

The information published herein is provided for informational purposes only, and does not constitute an offer, solicitation or recommendation to sell or an offer to buy securities, investment products or investment advisory services. Nothing contained herein constitutes financial, legal, tax, or other advice. These opinions may not fit your financial status, risk and return profile or preferences. Investment recommendations may change, and readers are urged to check with their investment adviser before making any investment decisions. Estimates of future performance are based on assumptions that may not be realized. Past performance is not necessarily indicative of future returns or results. No representation is made as to the accuracy, completeness or timeliness of the information in this material since certain information herein is based on or derived from information provided by independent third-party sources. There is no duty to update this information. Illustrations provided are for presentation purposes only. Actual investment experience will vary with stock selection and changing market conditions. Investment advisory services offered through Member's Wealth, LLC, a registered investment advisor. The Dow Jones Industrial Average (DJIA) is a stock market index of 30 prominent companies listed on stock exchanges in the United States. The S&P 500 index is designed to be a broad based unmanaged leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large cap universe or representative of the equity market in general. The National Association of Securities Dealers Automated Quotations (NASDAQ) is an American stock market that handles electronic securities trading around the world. The Russell 2000 index is an index measuring the performance of approximately 2,000 small-cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. The Russell 2000 serves as a benchmark for small-cap stocks in the United States. Visit www.russell.com/indexes/ for more information regarding Russell indices. The MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. The Bloomberg US Aggregate Bond Index, is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States.

About the Author – Dane Czaplicki, CFA®

Dane Czaplicki is CEO of Members’ Wealth, a boutique wealth management firm that offers a comprehensive approach to serving individuals, families, business owners, and institutions. The firm’s goal is to preserve and grow its clients’ wealth to endure over time, while thoughtfully evolving its strategy to suit an ever-changing world. With over 20 years of wealth management experience, Dane and the Members' Wealth team thrive on bringing clarity and confidence to clients' unique situations. He believes everyone needs sound financial advice from someone whose interests are aligned with theirs, and is determined to put service before all else.

Dane received his MBA from The Wharton School of Business at the University of Pennsylvania and his bachelor’s degree from Bloomsburg University. Outside work, he enjoys spending time with his wife and kids, hiking and camping, reading, running, and playing with his dog. To learn more about Dane, connect with him on LinkedIn.

To get in touch with the Members’ Wealth team today, I invite you to email info@memberswealthllc.com or call (267) 367-5453. 

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