In their January letter to clients, top value investors Whitney Tilson and Glenn Tongue of T2 Partners say their big recent losses on short positions have led them to rethink their overall shorting approach.

“Over time we’ve been quite successful shorting fads, frauds, promotions, declining businesses, and bad balance sheets,” say Tilson and Tongue, whose big losses shorting Netflix have been much publicized. (A tip of the cap to Market Folly for posting the letter.) “Where we have had much less success, however, especially in recent months, is shorting good businesses that are growing rapidly, even when their valuations appear extreme. Such open-ended situations, regardless of valuation, are very dangerous, so going forward we will avoid them entirely unless we have a high degree of conviction about a specific, near-term catalyst.”

Tilson and Tongue, who made big profits by holding a big short book heading into the financial crisis, say they made a major mistake in keeping a very large short book after the crisis had passed. Going forward, they say, their short book will probably most often represent 25% to 40% of their portfolio, though in times when they see major bubbles forming, they may significantly increase their shorts.

When major market declines and economic troubles aren’t imminent, however, Tilson and Tongue say “shorting is a terrible business”. And, while their current outlook is cautious, they stress that they do not think that we are “on the bringk of a major market and economic decline.” “Rather, we think the most likely scenario is that the U.S. economy will muddle through and slowly get better over the next few years.”