Jim Cramer is currently discussing the SEC's change in the "uptick rule" for short selling. Ticker Sense and Birinyi Associates has focused on this rule change since November 15, 2007 when we first highlighted that this rule change was causing fundamental changes in market activity.
We continue to agree with Mr. Cramer, although we may say that he now agrees with us. Nothing illustrates the underlying change better than the peak in the Dow's non-block money flow chart. Birinyi Associates is known for its money flow analysis, which is an analysis of each transaction in a stock and shows underlying activity behind seemingly small price moves. As shown, the Dow's money flow peaked in July of 2007 and has declined ever since. Short sales that can now be executed on any trade have caused the money flows to turn and this is also a reflection of the rule's impact on market activity.
In addition to the dramatic declines in money flow, the VIX and average daily change for S&P stocks have also increased since then.
Changing the uptick rule certainly did not cause the subprime meltdown, and would not have prevented a decline, but it has caused increased volatility and declines in stocks that would not have been so dramatic. In essence, short sellers are now able to sell stock that did not previously exist. While there is a buyer for the stock, essentially increasing the number of shares outstanding and offering those shares at a discount has caused stocks to fluctuate wildly. Since large amounts of capital are required to play this high-stakes game, many players have been driven out of the market. Investors have taken refuge in gold (peaked at $1,000/oz), and treasuries (10-yr yielding 3.31%).