Asian Contagion
Aug 31, 2009
Posted by Jody Eisenman | Filed under Uncategorized
While the stock market has been soaring ever higher the last few months, a “fly in the ointment” has now appeared. Yesterday, the ruling conservative party in Japan has been ousted after more than 50 years in power. As such, the Asian markets have had the predictable knee jerk reaction via selloff, which sent some of their markets down almost 7% overnight. European markets have dropped as well, but are down a more modest 2%. The Dow futures are down about 75 points before the opening. So far, every selloff since early March has been met with new highs.
I believe that one of the reasons for this is due to short positions. Many traders, who just do not believe in this rally, have been heavily short (betting that the market is going to decline). When you are short, your potential losses are theoretically unlimited (unlike a long position, which can only decline to zero). Thus, if you short a stock at say, 20, the stock could rise to 40, 50, or even 100. As the stock rises, your brokerage will require you to post larger collateral as margin. Many short sellers have been forced to cover either by design or because they could not post additional collateral, i.e. margin. Despite, short interest on the NYSE is currently close to all time highs. Inevitably, this will add to the volatility in the markets. If the shorts are right, the market will sell off. However, when they are wrong (as they have been for the past 5 months), you get these continued “short covering” rallies as the shorts get squeezed, and are forced to buy back stock at ever increasing prices. Some examples of this include AIG, which has exploded from 10 last month to close over 50 on Friday, and Fannie Mae and Freddie Mac (FNM and FRE) which have soared over 300% during this same time period. Past history tells us that such gains are usually unsustainable, but in a short squeeze, anything can happen in the short run. It should be an interesting September.
