Monday, September 22, 2008

Eating the Seed corn: Short Selling

This is an opinion piece. I haven't seen anyone put together the numbers yet to fully quantify what I'm speculating on. Naked Capitalism estimates that $200 Billion has been transfered from shorts accounts to closing those shorts.

Normally the role of short selling keeps a 'hot stock' from overshooting. As the stock becomes over-bought to its fundamentals, short sellers step in. Once the stock dives back down to supportable levels, the short sellers "take profits" and buy up the stock. This helps keep a stock from becoming too over-sold. There is a natural group ready to party with their profits.

With short selling on financial stocks banned:
1. It created a short uptick as shorts were closed.
2. Those shorts are gone. There is no downside protection. The $200 Billion (estimated) buying pool is gone.

If we start a new downward bearish stock trend there will be no quick recovery bounce. Normally short sellers jump in when there is an uptick to close their shorts. Now they'll be on the sidelines (maybe with put options, but that doesn't have the same stabilizing effect).

Healthy companies have cash and can penalize undue short selling with a stock buyback. It takes a company short on cash to be a short target. Those companies probably had overpriced stock anyway... I consider short selling a stabilizing effect on the market.

The law of unintended consequences will now come into effect. October is a scary stock month. Will we make it though ok?

Most of my competition has too much of their portfolio in stocks. So...

Interesting times ahead.

Also, printing money is going to really drive import inflation. I still predict domestic deflation combined with import inflation. The US standard of living is about to take a hit.

I've been asked by a relative to look into the effect of today's economy on medical spending. So that will be my next blog (unless I get to my emotions article first).

Got Popcorn?

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