"Growth for the sake of growth is the ideology of the cancer cell"
Edward Abbey

Various modifications of "Is this rally for real?" headline are slowly becoming a staple in the mainstream media. Everyone and their mother is now asking this question and stating various reasons why it is or it isn't the case. Here is a simple fact to consider from the "un opinionated" skeptical capitalist- Dow and Nasdaq are up 10%+ since the market bottomed in March! Given the fact that this double digit gain is most likely significantly larger than the average annualized return passive investors should expect over the long haul, why in the world would anyone question if this rally is/was for real? Giving up a double digit return for any reason in my book is simply irrational.

This rally is exactly the reason why I have been arguing passionately for a while now, that successfully timing the market is quite difficult achieve over the long haul, and thus an average investor should never move a 100% of his/her holdings into cash. If/when unsure about where the market is heading - it could much more prudent to move your cash into index ETFs like VO, VV, SPY, QQQQ than into cash or money market funds that don't even earn a high enough return to compensate for inflation. And if you are a true active investor- consider hedge using short positions. Remember, there is nothing wrong with being negative about the stock- it is perfectly ethical to give management the run for their money by questioning their silly actions and voting your dissatisfaction by selling shares... I actually think that if/when the "negative stigma" attached to the cruel "short selling" practice disappears, average investors will be much better off because the market will become more efficient.

Just imagine how much wealth has been irrationally shifted from the unscrupulous investors' accounts into the pockets of newly minted "dot com" millionaires during the tech boom, just because speculative actions of the bullish investors went unchecked by the widely outnumbered and heavily criticized bearish investors. Same thing with sub prime lenders and homebuilders in 2006-2007...

If only investors out there finally realized that instead of listening to the "whining CEOs" blaming evil "short sellers" for manipulating their stock prices, they could do much better if they listen to what these "evil" hedge fund managers are actually saying. While obviously short sellers aren't always right, they are more often right than wrong and high short interest usually indicates either temporary overvaluation of the stock itself, or could even point to a fundamental flaw in the underlying business model of a company that seems to be doing ok on the surface...

The reason for this phenomenon in my mind is quite simple- in the world where investing is now easily accessible to anyone with a computer and internet connection, the real edge comes from doing what most regular investors are still afraid to do- shorting stocks. This in turn implies that investors who short stocks are on average much more sophisticated than the ones who do not and thus their advise is likely to be more valuable.That is precisely the reason why I personally pay a LOT of attention to one widely underappreciated "Vad's secret hedge fund recipe" indicator- short ratio.

This ratio represents a number of shares of a particular stock that are shorted divided by stock's average daily volume over a certain period of time (usually 30 days). I, for example, use it on both sides of my investing strategy. When searching for stocks to short- I simply avoid starting a full position until the short ratio moves above 7 days. It is only one of the factors I take into account when making a decision to short a particular security, but it is definitely one of the more important ones.

On the long side, after my mechanical screening process identifies the top picks, I go in and manually dig through all the available bearish information on each stock with a short ratio of over 7. If I can't figure why the stock is disliked- I simply don't buy it. On the other hand if short ratio is high and I think I know why- the pick becomes a part of my contrarian "conviction" bet group with the appropriate allocation of no more than 3-4 positions and 15-20% total maximum weighting for the high short ratio group.

As an example my original "conviction pick" FSIN at the time I picked it carried relatively high short ratio. But to me it was pretty clear why- investors simply did not believe that management could deliver on its growth promises and also questioned the rationale of the stock dilution required to complete the Copperweld deal. I, however, decided that not only the fundamental growth story was clearly intact with copper/aluminum ratio firmly into Fushi's favor, but also that management has not shown any reasons whatsoever to actually doubt their business acumen and thus shorts were likely to be wrong. It is not clear who is going to be right in the long haul but to me a 35%+ return in just a few months is nothing to sneeze at...

It is true, that I could have theoretically shown returns much better than 18%+ plus enjoyed so far by focusing on a small number of "conviction" picks, as I have now selected a very long list of 35%+ winners on both short and long side. But in my "actively hedged" strategy the main focus is risk adjusted returns, which by default means higher number of picks and consistently significant short position. This strategy has worked for me so far and I have no intention of changing it.

On another note- I have been relatively quiet recently as I am currently in the process of officially changing my status from the " amateur to a real "pro". Beginning June 1st I will finally combine all of my skeptical capitalistic ideas into one full fledged hedge fund launched with a "back office" support of my current employer. Hopefully, given the fact I can now focus a 100% of my efforts on the actual portfolio management; my track record will only get better as time goes by. In the mean time, I will also devote much more attention to building my blog www.skepticalcapitalist.com into a useful resource for any active investor who is looking for some good monthly long/short investing ideas and unbiased economic/investing educational commentary.

For now, stay safe and please feel free to e-mail me with any questions at skepticalcapitalist@gmail.com