Raising his glass of beer the other evening at a dinner at Sparks Steak House, one Merrill Lynch trader toasted the bears. “Long live the shorts,” he bellowed, “they drove up the Dow to 12,000, and now they’re going to drive it up to 13,000.”

He’s hardly alone in his thinking about those bettors on falling stock prices, whose short covering was a major force in recently catapulting the Dow into record territory.

Raymond James Financial’s chief investment strategist, Jeffrey Saut, holds the same view, asserting that the 1200-point Dow rally since the July lows has been almost entirely because of short covering.

While some pros may toast the shorts, however, money manager Tom Postin, who presides over the investment of $280 million of assets at Los Angeles-based P &W Partners, is not among them. In fact, he would rather shoot them. The reason: He’s net short the market and the rally has been painful for him. “There are just too many shorts, a lot of them amateurs, who run for cover every time the market goes up,” he complains.

The fourth quarter of the year is traditionally the year’s best quarter for the stock market, what with the S &P 500 having averaged an annual gain of nearly 6.5% in this period over the past 18 years. And although Mr. Postin is bearish, he’s also fearful the current heavy short interest could fatten any year-end rally by perhaps another 3% to 5%, adding to his potential losses.

Because of this concern, plus his view that the Dow’s recent run to new highs is likely to spur a considerable amount of short covering — which, in turn, would drive stock prices higher — Mr. Postin has reluctantly begun to reduce his short positions in a number of companies, among them Avon Products, Dell, Pacific Ethanol, Intuit, Advanced Micro Devices, and General Motors.

The booming figures on the short side give credence to Mr. Postin’s concerns. In particular:

• Short interest on the Big Board stands at an all-time high of 9.74 billion shares, up 12.7% from a year ago.

• Short interest, as a percentage of market capitalization on the Big Board, is at 1.77%, the highest level since the bottom of the October 2002 bear market.

• Nasdaq’s short interest is a record 7.36 billion shares.

Given the huge short interest, investment strategist Bill Rhodes of Bostonbased Rhodes Analytics, which doles out investment advice to institutional investors with more than $1 trillion of combined assets, expects short covering to continue to be a significant driver of rising stock prices. Mr. Rhodes views ballooning short interest as a major plus for the market because, he says, it should make it run faster and go higher. Still, he hastens to point out while short covering can create spectacular fireworks on the upside, it can’t sustain the market because it usually runs out quickly.

It all raises an intriguing question: Which are the most dangerous shorts in the market, notably those stocks that are capable of shooting up the most in the face of heavy short covering?

Mr. Rhodes, who has done an analysis of what he describes as the riskiest shorts both on the Big Board and Nasdaq, has come up with a half-dozen names on each exchange. His conclusions are based on a company’s percentage of short interest, versus its floating supply of shares.

On the Big Board, his six most dangerous shorts are Brookfield Homes, WCI Communities, Superior Industries International, Krispy Kreme Doughnuts, Build-A-Bear Workshops, and Pre-Paid Legal Services. On the Nasdaq: Escala Group, Parlux Fragrances, CORUS Bancshares, South Micro Software, Jos. A. Bank Clothiers, and Crocs, Inc.

Though Mr. Postin allows for the prospect of a year-end rally, he thinks it will be modest because he’s convinced the current market euphoria should soon fizzle. In fact, he believes the beginning of a 15% to 20% decline in both the Dow and Nasdaq could kick off at any time.

Why so? One reason is his belief inflation is more of a market threat than generally perceived, which, he believes, could lead to another one or two interest rate hikes from the Fed.

He also believes Democrats will capture control of the House and possibly the Senate in next week’s mid-term elections, which he believes would unnerve the market on several counts. For example, a very strong Democratic showing, he believes, would spur a move to impeach the President, leading to a lot of chaos in Washington and the creation of a do-nothing government for quite a while.

He also thinks a big Democratic win would mean some key industries, such as pharmaceuticals, energy, and defense, could fall prey to brisk selling pressure because of the Street’s belief prospective changes would then be pursued by the Democrats that could make these sectors considerably less appealing.

He also thinks any signs of weakness in ending the Iraq war on anything but a firm and forceful note might encourage the terrorists to accelerate their efforts to pull off more attacks on American shores.

Mr. Rhodes, though bullish, in part because the market is broadening out, with more names participating in the rally, a narrowing of the bid and asked price spread, and low volatility, is not without his worries.

One is the massive margin debt (buying stocks on partial credit), which, he notes, is currently $797 billion, the highest level since August 2002. It’s a sign, he says,”we’re now in a frothy market.”

dandordan@aol.com