During the month of January the stock market`s direction for the year as a whole can be set by comparing the market at the end of the first month against where it began as trading opened for the year.
Barometer Definition
So firstly how did we look on the January Barometer this year?
Well, the Barometer for 2008 and the market differentials for the Dow Jones, S&P500 and Nasdaq were the following:
Dow Jones from Jan 02 to Jan 31 down 3.10%
S&P500 from Jan 02 to Jan 31 down 4.74%
Nasdaq from Jan 02 to Jan 31 down 8.17%
You can take a look yourself by following this thread QID
So what does that say about this year? (In the theme of the Equity Market Barometer, markets are obviously more complex than this)
Well if the last week`s performance is anything to go by I would say the January Barometer might just hold true just like another barometer often does. `Congress should consider legislation even before a new president takes office. The urgency is too great and markets will not wait` says Henry Kaufman often better known as Dr Doom. The president of the New York Based investment and consulting firm Henry Kaufman has been correct with predictions in the past but his comments around the US financial institutions lacking direction might just have accelerated the decline of the markets over the last week. Shares of Fannie Mae fell on its knees by 23% on Friday and Freddie Mac went out backwards as much as 51%.
In the fear that these two institutions would follow the same path as other prominent US financial corporations have done this year, the SEC issued an emergency rule limiting certain types of short selling. The regulator focused predominantly on naked shorting and not just across stocks in Fannie Mae or Freddie Mac but across all major financial firms. Nineteen institutions were targeted including Freddie Mac, Fannie Mae of course but also Goldman Sachs, Lehman Brothers, Morgan Stanley, JP Morgan Chase, Citigroup, Merrill Lynch, Barclays, Bank of America and Royal Bank ADS were also part of the list.
For those that are not familiar with short selling, it`s quite a simple although alternative trading strategy. In short no pun intended, an investor would arrange to borrow shares they consider overvalued and sell them in the hopes of making profit by buying them back cheaper.
In this case short selling might have accelerated the decline of weak organizations however; it is still claimed by many traders as being an important feature of the market especially as it self-regulates price spikes and concentrations within the market.
It all becomes a bit clearer with an example: Assume the shares of bank F&F were trading at $10 per share, a short seller would borrow 100 shares from an investor and then immediately sell those shares of F&F for a total of $1000. If the price of F&F shares later falls to say $9 per share, the short seller would then buy the 100 shares back for $900, return the shares to their original owner, pay him a fee for having borrowed his shares and make a profit of $100.
In the emergency rule that the SEC proposes, they are not directly prohibiting short selling just enforcing a strong stance against naked selling. In this case the SEC would require a short seller to borrow the securities before executing the sale and it is also going require the investor to deliver the securities on the settlement date.
This is not a first for the SEC and in the past it has considered emergency rules such as prohibiting naked short selling before. In mid 2007 the SEC attempted to implement a `tick test rule` which only approbates a short sale when the last stock price is higher than the previous quoted price but that mandate was revoked.
The SEC`s purpose here with all of these rules is obviously to avoid any additional collapses of US financial institutions and to improve confidence in the markets. Generally the industry as a whole has been struggling with tight liquidity and is still recovering from the now well known sub-prime lending crisis. If the SEC can control the steepness and acceleration of declining stock, some banks might have a softer landing and more time to react to downward pressure on their stock price.
In reality the number of banks that have actually collapsed since 2000 can be found at this address Failed-Bank-List. Those institutions such as Bear and Stearns which were acquired at an incredible discount or banks that have been pulled back from the edge of liquidation through aggressive recapitalisation techniques will not feature in this failed bank list. None the less losses to investors holding onto such stocks might still have been huge.
