So, what does the banning of short-selling mean to the market?
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.
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.
