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Friday, September 26, 2008 - Vol. 10, No. 230
Today's comment is by Eric Roseman, Investment Director and editor of Commodity Trend Alert.
A week ago today, a host of countries, including some emerging markets, banned short-selling financial stocks. In some areas, they banned short-selling altogether.
The United States Securities and Exchange Commission (SEC) banned shorting 799 financial companies until October 2. In doing so, they're hoping to stem the market crisis unleashed upon financial stocks.
This past Monday, the SEC added another 30 names to the list, including General Electric and General Motors. This marks the second time since July that the SEC has imposed a temporary ban on shorting financial shares.
By targeting and banning short-sellers, the SEC is barking up the wrong tree and removing one of the last market-based sanctuaries in a dreadful year for financial assets.
This legislation won't help the markets. In fact, it will ultimately create a new round of broad-based selling when the SEC finally lifts the bans. Also, it's possible that bank stocks have already bottomed (at least for this cycle) because a slew of financial indices are now all comfortably sitting above their lows set in mid-July.
Mid-July Might Have Been the Bottom for Financials
Since the last SEC trading ban expired, two Wall Street behemoths - Lehman Brothers Holdings and Merrill Lynch have either collapsed or merged with other companies. Obviously, the first ban in July did nothing to help these fractured financial services companies.
The Big Short Squeeze Doesn't Work
This isn't the first time a country has banned short-selling.
Recently in June 2007, Pakistan banned short-selling practices. Now, just 15 months later the market in Karachi is down by another third so that obviously didn't work.
England also banned short-selling in the 17th century following the collapse of the Dutch tulip mania. That effort also failed to calm the markets.
The SEC's ban on financial stock short-selling is primarily why global stocks posted huge gains last Thursday and Friday. Short-sellers scrambled to cover their bearish bets or were forced to buy back the same stocks they were betting would continue declining.
This classic "short squeeze" won't help alleviate market sentiment and points blame to the wrong segment of the market. If a company or sector should be valued at a lower multiple, then the government shouldn't interfere in a free market. This response will only delay another day of reckoning as banks face mounting losses on traditional lending practices, including credit cards, auto loans, and other facets of lending.
We Short Because It Makes the System More Honest
Short-selling means you're borrowing shares because you anticipate selling them in the future at a lower price. It allows you to be bearish on stocks that you don't own. From a practical standpoint, short-selling also creates truth in an otherwise corrupt marketplace where some companies dodge accounting rules and fudge their books to hide losses.
The latest salvo fired at short-sellers this month targets the wrong group of traders. These short-sellers actually help to create liquidity in the markets and stem market bubbles.
Short-sellers try to honestly target aggressive accounting practices. And more often than not, these traders help create balance in an otherwise heavily manipulated market.
Short-sellers are also racking up the best returns in 2008 among diversified hedge fund strategies. By some accounts, short-sellers have gained more than 10% this year through August and they're up 12.5% over the last 12 months. In September, estimates point to another 5% gain for this group, while traditional equity benchmarks have crashed by about a quarter.
One of the more respected short-selling specialist firms - Kynikos Associates in the United States - was one of the first firms to isolate questionable accounting at Enron. As I'm sure you heard, Enron CEOs were either prosecuted or heavily fined and will never be allowed to manage a public company again.
SEC Downgraded to Junk - Thanks to Chris Cox
SEC Chairman Christopher Cox has finally awakened from a deep sleep that lasted 13 months. Presidential candidate, John McCain, publicly denounced Cox last week claiming the first thing he would do if elected this fall is fire Chris Cox. I agree.
The SEC was literally asleep at the wheel until July. They were doing absolutely nothing to police aggressive accounting by financial company CEOs. And they did nothing to warn investors about suspicious accounting, aggressive sales practices involving mortgage-backed securities, or the bubble that inflated among mortgage offerings.
The other high-risk, dangerous securities, including collateralized debt obligations (CDOs), credit default swaps (CDSs), and other credit derivatives are not even regulated, let alone scrutinized by the SEC.
What was the SEC doing all this time as financial markets were hemorrhaging?
Instead of doing its job ensuring that U.S. capital markets are properly regulated, the SEC is now pointing fingers to short-sellers and blaming this highly skilled group of traders and analysts for the markets' crash earlier last week.
Yet Cox, in a public statement earlier in his tenure claimed, "We need the shorts in the market for balance so we don't have bubbles."
Shorting Is American as Apple Pie
By banning short selling the government is effectively saying that it's trying to determine where stock prices should settle. That's not what a free market is about. This response damages the credibility of the free market system and ultimately suppresses the true value of an entity.
If the SEC and other governments can ban short-selling, then one has to wonder which segment of the market is next to face regulation or restrictions...
Is Gold Next?
In 1933, under Executive Order 6102, FDR confiscated gold ownership. Under extreme market circumstances governments can impose extraordinary measures that usually do not benefit the poor, unsuspecting investor.
The current financial crisis in the United States is the worst since the Great Depression and might warrant other measures that confiscate foreign currencies, precious metals, or other international assets and securities. Anything is possible.
As this crisis eventually fades or possibly gets worse, investors should use the offshore private bank account window before it closes. It's still legal to move money to Europe. The best destinations for asset protection remain Switzerland, Liechtenstein, and Austria.
Having some gold stored in these European countries is a powerful safe-haven strategy amid extreme economic circumstances. It will give you the high margin of safety you'll need to protect yourself from the next financial debacle.
ERIC ROSEMAN, Investment Director
EDITOR'S NOTE: Believe it or not, there are still some great buying opportunities out there amid the chaos. But you have to know exactly where to look, and Eric does. He's the brains behind America's #1 Research Service, Commodity Trend Alert. Out of 41 open positions (including losers), he currently has an average return of 86%...even while major institutions drop like flies. Due to his outstanding success, we're doubling his research budget to help him find even more winners. But please act fast, because the price of this service will be doubling next Tuesday to accommodate this extra research. Get all the details here.
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