14th August 2012
Alternatively, it is the work of evil hedge fund managers and manipulators making a killing at the expense of others. Some have pointed to short sellers being the only market participants cheering each time Facebook falls.
More generally, the negative views on this activity have led to bans on shorting banks and other financial groups – some have blamed the ability to bet on a share falling for much of the financial instability of recent years. There have been a number of bans on short selling banks. Whether these regulator inspired moves protect the targets or simply delay the inevitable is always a matter of conjecture.
Now, however, the shorting phenomenon seems to have four wheels. Investors, according to the Financial Times, have started to bet on European car manufacturers falling out of grace.
China and currency pressures
The line is that shorting car stocks is at its highest since mid 2010 as investors bet that a combination of currency difficulties, falling demand, especially in China, and a feeling that the companies' equities are currently overvalued, will push share prices down. This will present short sellers with a cash bonanza. And as this shorting would appear to be motivated by genuine reasons rather than automated trading systems, investors need to take notice.
Few investors these days participate in naked or uncovered shorts – illegal in most jurisdictions. Instead, they borrow the stock for a fee from an institution. This stock lending is controversial – some fund managers keep the charges for themselves rather than giving them to ultimate investor, a practice to be outlawed by new European rules.
Once a company has more than three per cent of its stock lent out in this way, market participants can consider that it is susceptible to shorting. Last week, an average of 3.8 per cent of shares in carmakers on the Stoxx Europe 600 index were out on loan last week, compared with 2.7 percent across the Europe-wide index, according to Markit.
A year ago, the figure was closer to 2.5 per cent – the increase has highlighted fears of overvalue in a manufacturing sector where the European presence remains significant.
Peugeot out of favour
Peugeot, the French mass market maker, and Fiat are most under shorting pressure. Peugeot has seen its share price fall by half over the past year while short interest, measured by the proportion of stock out on loan has doubled to nearly 15 per cent.
European consumers cannot afford so many new cars, which in any case have a longer shelf life due to increased reliability. Fiat chief executive Sergio Marchionne has called the competition from Japan as well as lower cost Far East makers which has led to price cuts, the auto equivalent of a "bloodbath".
The share price crash in the mass auto sector is made worse because makers of luxury cars such BMW and Porsche have so far evaded the carnage. Their equities may even have received a boost as investors shorting Fiat, and Peugeot are hedging their exposure to the auto industry in Europe with long positions in the upmarket sector.
Volkswagen, with a portfolio of brands ranging from Bentley to Skoda, is the latest to come under the attention of short sellers as investors fear that financial forecasts could be revised downwards – even in the luxury sector as any Chinese slowdown will impact hard.
To ban or not to ban – that is the question
It is unlikely that regulators will ban short selling in a sector such as motor manufacturers. But if they did, what might happen?
The New York Federal Reserve thinks it might be very little. It says: "Bans on short-selling imposed during the financial crisis in the belief that short sales were driving United States stock prices below fundamental values did little to stabilize those prices. In addition, the bans had the unwanted effects of lowering market liquidity and boosting trading costs."
In a study for the NY Fed "Market Declines: What Is Accomplished by Banning Short-Selling?" New York Fed economist Hamid Mehran and Notre Dame finance professors Robert Battalio and Paul Schultz looked at the link between short-selling and market downturns.
They found in a statistical exercise conducted to determine the relationship between short-selling and stock returns, "the two variables are minimally correlated."
The academics add: "The 2008 restrictions [on short selling] did little to slow the decline in the prices of financial stocks; in fact, prices fell more than 12 per cent over the fourteen days in which the ban was in effect. In addition, the bans increased trading costs in the equity and options markets by more than $1 billion. Moreover, there is no evidence that stock prices declined following the downgrade of the U.S. credit rating as a result of short-selling."
Investors can conclude that bans may delay an asset price fall but not prevent it.
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