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Friday, August 28, 2009


killing off retail short interest

this is deeply unfortunate, as the entire point from my view of having access within a 401(k) plan to a directed brokerage option is to enable hedging.

Recently, both the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) have cautioned against the use of Leveraged Exchange Traded Funds (ETFs).

Their concerns are that these funds are highly complex financial instruments that are typically designed to achieve their stated objectives on a daily basis. Because leveraged and inverse ETFs are reset daily, FINRA and the SEC caution against the use of these funds for investors who plan to hold them for longer than one trading session.

Princor Financial Services Corporation, like several broker-dealers in the industry, has taken the position to no longer allow access to leveraged ETFs, beginning on Friday, August 28, 2009. PrincorĀ® will no longer allow purchases in these securities; however, liquidations will continue to be permitted.

i don't doubt that some folks have mauled themselves with ultra proshares -- but that's an argument against defined-contribution retirement planning in its entirety, not any particular instrument. principal and other administrating brokers may not realize that's what they're actually saying, and certainly they don't want to say that, but that is the core of their assertion. if you can't be trusted with a straightforward, well-explained and simple "highly complex" derivative ETF such as these, you really can't be trusted with any aspect of self-planning your financial future. and so 401(k) plans themselves are really quite a bad idea, particularly in comparison to some form of compulsory social insurance.

that is, frankly, an argument i have a great deal of sympathy for -- but i sincerely doubt principal is trying to make it. indeed it isn't hard to imagine other reasons for a forced buy-in of retail short interest, particularly amid the aftermath of one of the great asset price collapses in the history of western civilization, one which has sent any number of insurers and other financial intermediaries whose balance sheets are predicated on, among other things, equity price levels to the brink of destruction.

one might expect that such concerted efforts would drive short interest to very low levels -- and indeed, by the tally of bespoke, it has fallen to the level last seen in february 2007. of note is that bespoke expresses short interest as a ratio to the float; shares short outstanding here. one can see that NYSE shares short are down on the order of 20% from august 2008, but the short interest ratio is down closer to 45%. this is testament to the massive equity offerings that have flooded the market, particularly in the financial sector, as firms have tried to raise capital.

february 2007 was a period when the S&P was marking new post-dotcom highs just prior to the shudder sent through the markets by the reversal of the chinese equity bubble which, for my money, marked the beginning of the global debt collapse even if american shares continued to rally for some months thereafter. margin debt was then at an all-time high, retail mutual fund cash at an all-time low -- balance sheet risk for retail investors was at a maximum, and the suckers were all in. immediately thereafter paul mcculley introduced much of the investment world to hyman minsky, and we've spent much of the last two-and-a-half years living out minsky's hypothesis.

in any case, i suspect the huge short squeeze of recent months, in combination with excess liquidity from banks and other government funding recipients seeking a return, has provided much of the rocket fuel for the markets since march. though the lesson might have been learned in the aftermath of the financial shares short sale ban in the UK and US in september 2008, sucking forward and eliminating all that future demand through covering and forced buy-ins -- and replacing it with a latent pent-up supply -- creates the potential for a terrible air pocket beneath shares, diminishing both liquidity and future demand. i find few market tells more convincing than extremes in short interest.

UPDATE: pragmatic capitalist also adds that reporting hedge funds haven't been so long (31% net) since june 2008. that's still a far cry from the 47% of early-crisis third quarter 2007.

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