Shorts to Balance your Portfolio

10/13/2006 12:00 am EST


Jamie Dlugosch

Editor, The Rational Investor

Investors can always count on Jamie Dlugosch as the 'rational' voice in the markets. And while his outlook for the Dow is more restrained than many on Wall Street, he offers investors several ways to profit, including the following shorts.

"Since its surge upward on Thursday, everyone's been talking about the possibility of the Dow reaching a new record close. I believe the movement indicates a shift in the market from riskier to more stable Dow components. I have been suggesting that investors focus on larger companies, and doing so is being duly rewarded now and will be in the future.

"One of our newest shorts, Starbucks (SBUX NASDAQ) announced same-store sales rose 6% in September, causing the stock to open higher the following day. The upside is that subscribers should have been able to short it near its peak; however, we could see more rises due to momentum trading despite how overvalued the stock is. To protect against this, I recommending using a hard limit order to cover this short at $44.

"We've also added a short position in Chipotle Mexican Grill(CMG NYSE) to help cut down on saturated price/earnings ratios.

"In addition to the individual stock shorts above, I want to add some short exposure to certain sectors that I think are vulnerable to a correction. We already have several shorts in the homebuilding sector, but I think short exposure to small-cap stocks and the semiconductor space is a good idea now.

We've added a short position in iShares Goldman Sachs Semiconductor ETF(IGW AMEX) to make the most of short-circuits in semiconductor stocks. The ETF is made up of many companies participating in the semiconductor industry. I recommend a short position on this fund up to a 2% portfolio allocation at current prices, with a target price of $49.

"Finally, we took a position in the Rydex Inverse Russell 2000 Fund(RYSHX) to capture the potential downside in small-caps after their big bull run over the past several years. Since the fund is technically not a short (though its strategy includes using shorts to match the inverse performance of the Russell 2000 Index), you'll find it on the website under "Mutual Funds" on the Buy List page. I recommend up to a 2% portfolio allocation in this fund, with a buy limit of $41 and a target price of $48.

"If you believe as I do that the economy is faltering and the market is aging beyond the average bull run, then making money will be more and more difficult. Our best shot to add positive returns is by shorting certain stocks to complement our long positions in undervalued large-caps."

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