Philip O'Sullivan's Market Musings

Financial analysis from Dublin, Ireland

Market Musings 12/8/11

with 6 comments

Markets rebounded a bit yesterday, but remain well below recent highs. Since my last update the main news has been the introduction of a short-selling ban in a number of EU member states, which I’ll look at in more detail below, while other things that have caught my eye include the price of gold, poor economic indicators in the UK and France, and also some corporate newsflow.


First up though, I was pleased to be “welcomed back” (!) by two readers who posed some really great questions to me about commodity prices and the short-selling ban yesterday. If there are any topics, within reason, that you’d like me to visit on this blog, feel free to get in touch and I’ll tackle it them here asap.


When the rumours about the introduction of a short-selling ban emerged yesterday afternoon, my initial response was to say that (i) this will does nothing to cure the problems in Europe’s banks; (ii) such measures have failed to work before; and (iii) bans are counter-productive because they increase the perceived riskiness of assets that are the subject of such bans, as market participants will no doubt become more wary about investments where governments and/or regulators intervene to significantly change the rules of the game.


These counter-arguments were put to me:


Well it’s time for something radical

It’s better than doing nothing and have rampers profit from what is nothing short of criminal with no risk of prosecution

If Italy and Spain are happy with their fundamentals they will not suffer from a suspension of short selling

The Irish and US experiences with bans are poor examples to give


My quick response to those four arguments are: (i) I agree that radical policies are needed, but I don’t see how a short-selling ban will do anything to cure the patient; (ii) The short-sellers wouldn’t have been circling around the banking sector unless something was very rotten in the system; (iii) Italy and Spain’s “fundamentals” – sclerotic growth, substantial public debt, big deficits, dire demographics, structurally high unemployment – would make me nervous; and (iv) I think using a fellow peripheral European country and the country where this bank problem first really started to emerge is fair.


To the above I would add the following: Bloomberg’s Mike McDonough, who is a must-follow on Twitter, produced this great chart which shows the experience of a short-selling ban across five countries, adding the UK, Germany and the Netherlands to the two I provided as examples.  As I said above, the ban does nothing to address the fundamental reasons why the market has turned negative on financials, namely worries about the growth outlook, the increasingly likelihood of substantial write-downs on holdings of sovereign debt and political calls for a punitive tax on banks. These problems will not go away as a result of  a trading restriction which Galileo Global Advisors describes as “knee-jerk” in a FT article that’s well worth a read. In particular for this bit:


A 2005 Cornell University study looked at short selling rules in 111 countries and found no evidence that bans reduced the frequency of market crashes. More recently, the International Monetary Fund found that 2008 prohibitions “did relatively little to support the targeted institutions’ underlying stock prices, while liquidity dropped and volatility rose substantially”.


Elsewhere in the FT, the influential Lex column concludes with this point that mirrors part of the argument I made yesterday:


Market gravity pulled weak companies down, as investors recognised that the shorts were right. When pessimism is justified, bans will not stop the truth from emerging.


Turning to France, earlier today it announced that second quarter GDP growth came in at zero, below consensus of +0.3%. Clearly this is the last thing Sarkozy et al need after the recent concerns about its economy. Staying with macroeconomic news, a study by LSL and Acadametrics says that UK house prices have fallen to a 19 month low.


In the commodity space, gold futures hit $1,800 an ounce earlier this week but have fallen back a little on CME margin hikes and also the uptick in equity prices. Given how volatile markets are at this time, I wouldn’t be surprised to see the upward trend resume in the near term – Merrill Lynch reckons gold will hit $2,000 in the next 12 months, which looks easily attainable given the troubled backdrop and the possibility of another round of quantitative easing in the United States. The margin increase serves as a reminder that while the path of least resistance is up, it will be a rocky one. One of my readers has asked if I can provide…


An analysis of the equity and businesses surrounding gold extraction and trade


…which is something I aim to tackle over the weekend, along with the dividend yield report I promised yesterday!


Finally, one “grey market” name I’ve written about before is One51. It released its 2010 annual report yesterday, which revealed a solid underlying performance, with pre-tax profits (before exceptional items) rising to €24.5m from €19.5m in the previous year. Its NAV of €2.56 per share was well down on the €3.66 at the end of 2009, with most of this decline down to a non-cash impairment charge on the value of its listed and unlisted investments. The main worry I would have on this front would be the value of its NTR stake, which it includes in the books at €48.7m, or just under 40c a share. Even if you wrote this to zero (which would obviously be an aggressively cautious step to take), you still get a NAV of over €2 a share, versus a current share price of €1.00. While its illiquid grey market status and significant Irish exposure mean that a discount to NAV is warranted in my book, a 50%+ discount looks excessive to me. One way that it could help to address this discount is by transitioning to a listing on the Irish Stock Exchange, which would improve the marketability of its shares. One area that has attracted media attention is remuneration levels at the group. While it is easy to point at how much the top dog in any company is paid, overall employee costs should not be ignored. The total P&L charge on this front of €65.4m was -6% from the previous year, while average wages & salary costs of €38k per employee (a whopping 14% below 2009 levels) are hardly excessive.


Two highly alarming stats to chew over – the percentage of Americans who don’t have $1,000 in savings to cover emergencies? 64%. The percentage of Americans who don’t have any savings whatsoever to cover emergencies? 24%.


And finally, seeing this gold-dispensing ATM was a highlight of my recent trip to Dubai.


Written by Philip O'Sullivan

August 12, 2011 at 9:17 am

6 Responses

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  1. My fundamental point re agreeing in principle with short selling bans is that the market is now so powerful and access to information as well as the sharing of it so readily available that when it turns on a system it can over power it.
    I made a reference yesterday to a graph that I cannot find now of the short sellers taking on Italian 10 year bonds. There was over 3.2 Trillion Euros in bets waiting to be matched by anyone brave enough to take them on. That is overpowering in anyones language.

    I was in Cheltenham in 2008 the day the letter surfaced that casued the run on Anglo and it was shameless ramping that contravened every single law of market trading.
    The letter was one of a number that Anglo had written to developers offering them discounts on the money they had borrowed if they repaid it early. The letter I saw was to a developer based in Manchester who owed them €15M and Anglo had offered to clear it for €12 Million.
    You can imagine the effect this had as it was shown around to 50,000 punters at the track.

    I agree totally with Philips’s view that a ban on short selling only serves to highlight shortcomings but none the less if it has gotten to that stage then it is too late anyway and the result is going to be the same.
    How does it benefit a country if a hedge fund run by one of the banks in the US decides to take them on and then ramp their bet up to make it a self fulfilling one.

    • Hi Denis,

      A quick response as I’m heading out to the cinema – I would like to see that graph you have on Italian short selling – €3.2trn sounds implausible given that this is more than double Italy’s GDP. Again though I would say that there is little evidence of short bans working to “cure the patient”. Unless European governments address their fiscal situation sentiment towards them will worsen and there will be few buyers of new bond issues – which a short ban has no effect on.

      I can’t comment on the Anglo letter you cite not having seen it myself. You do make an interesting point in the last paragraph but against that I would say that while I know of cases where this has happened with companies, the onus is surely on the company (or country) to sell a positive counter-argument to the market. In the current situation, it is difficult to see how Europe can spin its way out of trouble given the weak fundamentals I have written about for some time.

      Philip O'Sullivan

      August 12, 2011 at 5:39 pm

  2. […] weak Q2 GDP data earlier today, with growth of just 0.1% qoq well below consensus of +0.5% qoq.  This follows on from the similarly weak and below-consensus GDP reading from France a couple of days ago. The three things that immediately come to mind are as follows: (i) This […]

  3. […] reason bank share prices were under pressure and banning it has not relieved that pressure“. This sounds like something I wrote at the time this ban came in, doesn’t […]

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  5. […] on short-selling financial shares. This is a long-overdue move, although the ban did illustrate, as I have shown before, the futility of such restrictions. This may focus some attention on the anomalous valuation of […]

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