The Mother of All Short Squeezes

In the aftermath of the SEC’s decision to finally start enforcing Regulation Short Sales (RegSHO) on July 15 by banning naked short selling in 19 banking and financial stocks, I wrote an article entitled Mother of All Short Squeezes.  In it I made the following comments:

In their monthly Short Interest Report on July 16, Bespoke Investment Group updated their short interest numbers showing that short interest as a percentage of the float continued to increase during the second half of June with the average short interest hitting 6% for the S&P 500. Over the last year, short interest has increased 48% for the 500 stocks.

Bespoke also found that the 10 percent of stocks in the S&P 1500 with the highest short interest (150 stocks) gained 15.1% in the two day period ending July 17, 2008 compared to just 2.2% for the 150 stocks with the lowest short interest.

Not surprisingly given the government bailout plan announced this week, Fannie Mae (FNM) and Freddie Mac (FRE) enjoyed the biggest lift jumping 89.5% and 74.5% between July 15 and July 18. But as of the July 18 close, they were still down 61% and 72% in the last four months (since March 20). 

The article discussed some of the other beneficiaries of the incredible short squeeze that was occurring in financial stocks that week.

Bespoke also found in a study of rallies in the last five years that the decile of most heavily shorted stocks (those with the highest short interest as a percentage of their float) experienced the greatest gains. The painful downside however, is that the most heavily shorted stocks also led the market to the downside during a correction or bear market.  

It’s nearly midnight on the West Coast as I write this, and Bloomberg has just announced that the SEC is joining the British Financial Services Authority [FSA] in banning shorting of all financial companies (as opposed to naked shorts which the SEC attacked in January 2005). Problem is, the SEC never really put much effort into enforcing RegSHO, that is until this week when it was forced to play catch-up when markets turned truly ugly.  

These moves in London and Washington follow a similar action in Moscow to ban short selling by the Russian government in an effort to calm panicky markets. Many including yours truly think it adds even more credence to the axiom that the term 'government intelligence' is an oxymoron. But the real question is, will it work?

(click to enlarge)

 

Figure 1 – Weekly chart of the S&P500 showing short squeeze that resulted in the week of July 18 (green arrow) with sudden action by the SEC to ban naked short selling in 19 banks and financial institutions. Also note that like the Dow Jones Industrial Average and DJ Utilities Average that have both put in bearish head & shoulders chart patterns, the SPX looks like its trying to do so too. (Chart by GenesisFT.com_)

As we see from figure 1, the decision to ban naked short selling in 19 financial companies on July 15 by the SEC caused a huge short-covering rally but as we also see, it was short-lived.  

As we wait to see how the crew aboard the SEC Titanic will rule on such instruments as put options and how they will deal with inverse or bear ETFs in which money managers short stocks to provide profits, markets will undoubtedly rally and it should be at least as powerful as the one in mid-July.

But if history is any guide and we are in a bear market, it's a move that will prove to be short after which stocks are likely to return to their familiar journey to lower prices. 

However, this action reveals one unpleasant reality and that is that minions at every level of government, from regulator to political candidate, share a common goal.  No action, regardless of how costly or disruptive to long term stability, will be considered too drastic in the futile attempt to stop the bursting of asset bubbles. 

And finding a scapegoat is a big part of the larger bureaucratic strategy of trying to gain public approval in a crisis. However, like the misguided attempt to stop bubbles from bursting, it is an effort that will ultimately prove futile.   

Disclosure: None

Comments

[williambanzai7:]

From The Soundtrack : Ghostbusters (1984)


SHORT Busters…


If there's somethin' strange on your balance sheet
Who ya gonna call (shorttbusters)
If it's somethin' weird an it don't look good
Who ya gonna call (shortbusters)

(Lehman) I ain't afraid a no shorts
(AIG) I ain't afraid a no shorts
If you're seein' CDO's ruinin' your networth
Who can you call (shortbusters)
An' invisible trade dragging down your spreads
Oh who ya gonna call (shortbusters)
(Merrill) I ain't afraid a no shorts
(Bear) I ain't afraid a no shorts
Who ya gonna call (shortbusters)
Morgan Stanley: If you're all alone pick up the phone
An call (shortbusters)

(Paulsen) I ain't afraid a no short
I hear it likes Goldman
(Goldman) I ain't afraid a no shorts
Who you gonna call (short busters)
Mm…if you've had a dose
Of a naked short baby
You better call short busters
(SEC Cox) Bustin' makes me feel good

2008 Sep 20 12:08 AM

[ain't no fo...:]

Your friendly PPT/ Plunge Protection Team at work once again, as the election grows near... the brokers (those that are left) engineer a short squeeze with all that free taxpayer monopoly money benjie gave them from the discount window candy store.

2008 Sep 20 01:59 PM

[Jimbo:]

Perhaps I am naive, but if I were to advertise something for sale on E-bay that I had never owned and could not, would not deliver after someone paid me, that would seem to me to be fraud. I understand that there are some short sales out there that are something like 200-300 days overdue for settlement. Several posters on SA have expressed there fervent belief that short sellers somehow benefit the market. So called "naked" shorting strikes me as nothing but pure theft!!~!

2008 Sep 20 01:59 PM

[Jimbo:]

Sorry, "there" should have been "their"

2008 Sep 20 02:00 PM

[Matt Blackman:]

Jimbo
You are right. Naked shorting without covering the short within the max 13 days allowable under SEC rules is theft plain and simple. Another way of looking at it is that it's counterfeiting. Selling shares you don't have.

If you haven't yet seen the excellent documentary called Phantom Shares that ran in March 2007, I highly recommend it. A more detailed naked shorting explanation and link to the video and a number of other naked short articles can be found at tradesystemguru.com/co...

2008 Sep 20 04:19 PM

[helplessobs...:]

There is nothing wrong with shorting shares that have been borrowed. Every margin account agreement allows borrowing the account holders shares. Your borrowed shares are protected by:
1. proceeds from the sale do not go to the borrower. they are held by the broker. he gets any interest paid on these funds.
2. added to the proceeds are margin funds usually equal to 30% of the
sale proceeds. if the trade loses, more margin is required or the position will be closed
3. any and all dividends declared are paid by the borrower
4. the margin account holder will notice no change in his account statement. if he sells his shares the broker shifts the short sale borrowed shares to another account.

It should be noted that short sellers stand ready to buy your shares in a down market when nobody else wants your shares thus protecting your gains or limiting your loss.

2008 Sep 21 12:52 AM

[hurls111:]

The SEC is useless. 13 days to cover is a better deal than we get when we buy and anyone who can't handle that should be subject to criminal penalties for fraud. Maybe we can get some of the state attorney generals to go after illegal shorters.
Also, if you are a fund manager , don't you have to be a moron to lend your stock so someone else can drive down its value? Just wondering.

2008 Sep 22 01:25 PM