To Short or Not to Short

Yesterday I wrote about how the ramifications of the worsening U.S. housing market could be more devastating than most economics think.

Here’s the million dollar question:

Should you short the stocks of the largest U.S. homebuilders?

That’s a question I’m often asked these days. After all, most big home-builder stocks have been in a free fall for months–and the U.S. housing market is only starting to get bad.

Shorting stocks is not for the faint of heart. If you are a conservative investor, you shouldn’t even think of it. If you can afford the risk, I think the housing stocks (only the largest cap ones) are a good bet. But I also think large consumer retail stocks are an even better bet.

Courtesy of Bernanke’s decision to leave interest rates alone the last couple of Fed meetings, the stock market is sensing lower interest rates ahead. And there’s nothing the market loves more than lower rates. The stock market acts like it’s not concerned at all about the slowing economy. It’s just “bring on the lower rates and let’s party!”

The rising Dow Jones Industrial Average is taking all kinds of stocks up with it, including retail and housing stocks. Thank goodness, otherwise housing stocks would have been on a red hot fire sale.

I’ve publicly stated I predict the Dow will soon move to a new record high, beating its previous high set in 2000. But, I also said I see the move as a fake-out to bring retail investors back into the stock market–we are seeing a classical bear trap in the making.

But there’s no escaping the natural effects of a slowing economy. There’s not doubt in my mind that once consumers digest the fact they went from “house rich” to “house poor,” big retail will feel the effects. Hence, retail stocks might actually be a better short than housing stocks. Something to think about.