Not surprisingly the ASX/S&P200 looks as though it is going to get off to another strong start this morning.
We dare say you have all had the opportunity to digest plenty of information over the weekend. Newspapers and websites have been screaming about financial Armageddon. Two weeks ago very few people would have heard of Henry “Hank” Paulson. Today he is almost a household name.
A quick summary of what has happened over the last few days in chronological order.
Markets have slumped. The US government has proposed buying up bad debts from US banks. The US, UK, France, Germany, Switzerland, Canada and now Australia have implemented various bans to prevent or limit short-selling. Markets have soared.
European Markets Make Big Gains
Deep breath. Where do we start? European markets went bonkers on Friday.
FTSE100 - up 8.84%
Dax30 - up 5.56%
CAC40 - up 9.27%
Euro Top100 - up 8.26%
And we thought the Australian market was doing well when it posted a 4.3% gain.
The Next Wave?
What happens next? Well, you’ve probably got just as much of an idea as we have. But we won’t fall into the trap of saying that US government intervention is the end of ‘Free Market Capitalism.’ Mainly because we aren’t convinced that it ever started in the first place. We’ll leave that argument for another day.
Back to this morning. Just when we thought things couldn’t get any more bizarre, it does. On Friday the ASX notified market participants that it was going to ban naked short selling. That’s selling shares that you neither own, nor have borrowed. It doesn’t mean selling board shorts while unclothed.
Then late yesterday the ASX changed its mind and decided that any form of short selling was to be banned for a period of thirty days. The flow on effect of this is that many participants were not aware of this news until arriving at their desks this morning.
The consequence? The ASX delays the market open until 10.30am. Yet as we approach 11am there is still no action.
Short Selling Banned
So, what does the banning of short-selling mean to the market?
I received an email this morning from a Money Morning reader asking, “Is short selling really to blame or is it only a scapegoat?”
It’s a good question. In our view, short-selling is no more to “blame” for markets falling than long buying is to blame for markets rising. In other words, it does have an impact on the downside but only as far as it adds to the number of sellers. It is not the sole reason for a share price falling.
We keep hearing commentators and analysts tell us that the likes of ABC Learning and Babcock & Brown are fundamentally strong companies. We are told that they hold great assets and that the market is failing to recognize it.
We wrote in Money Weekend a couple of months ago that it was a misleading argument. Sure, these companies may have good assets, but that is only one side of the balance sheet. Don’t forget about the debt on the other side. If we only concerned ourselves with the assets then share prices would never go down.
Cause and Effect
It is easy to confuse cause and effect. Short sellers aren’t the cause of a share price falling. The cause is due to something that the company has or hasn’t done. The effect of the company doing (or not doing something) leads to investors selling those shares. In some cases this will involve investors short selling.
In reality, the ban on short-selling is likely to have almost zero impact. There may be short term price action to the upside as those who currently have short positions buy back the stock to close out. Secondly, those investors that use short selling to hedge a long position may choose to close out their long positions, which could put pressure to the downside.
But for those professional investors wanting to trade ’short’ they need look no further than the Options market. Options traders will be able to implement reasonably simple strategies that will give them almost exactly the same exposure as if they had used the share market to short sell.
In financial terms they call it a “synthetic short.” By simply buying an ‘at the money’ Put Option and writing an ‘at the money’ Call Option the trader can replicate a short trade. It is not exactly the same, but if an investor really wants to short particular stocks it is an easy way to do it.
The bigger question is what will happen to the markets next. We all have an interest in share prices rising, but are we really interested market manipulation?
ASIC and the ASX have rules against investors falsely manipulating the market. Yet its actions to restrict short-selling are doing exactly this in the short term. The banking stocks again look likely to be the main beneficiaries of this policy when they eventually start trading this morning.
What Happens When the Party is Over
The party on the stock market will doubtless continue today after Friday’s celebrations. But as is usually the case with a big party, there are plenty of hangovers.
Governments and regulators have thrown everything at the markets over the past week to try and ‘fix’ things. It may work. But if it doesn’t they haven’t left themselves with many other options.
Cheers.
Kris.
