Short Sale Ban to Come?

Banking on a Short Fuse

A potential short-selling ban may be on the horizon with recent financial sector volatility. If you are a regulator and want to signal you think the market is at fault for doing the job that you, the regulator, ought to have done, then it kind of makes sense (I guess?) to get in front the market by saying ‘you can’t do that anymore’, we will deal with it now…Like I say, I think it makes sense, or you could just let the market do its job of holing out the sector and righting it again. It probably is less messy to find a regulatory solution but you have to find it and first you have to draw a red line.

So, a Reuters report says US officials are assessing whether "market manipulation" sparked the recent volatility in bank shares. At the same time the White House said it will monitor "short-selling pressures on healthy banks."

We love a short-selling ban. Bafin did it for Wirecard...and we know how that ended up. The market was doing the job the regulators ought to have done with Wirecard. The SEC in the US has been before – banning short sales on US financial stocks in 2008, stating that “unbridled short selling is contributing to the recent sudden price declines in the securities of financial institutions unrelated to true price valuation.” Research carried out on this ban, and a similar one in the UK, after the crisis showed they actually tended to reduce market liquidity and slow down price discovery, while failing to prevent declines based on economic fundamentals. A 2014 Cass Business School study paper looking at examples from 2008-09 and 2010-11 suggests a ban leads to more volatility, greater declines in stock prices and a higher likelihood of default. Bans suggest weakness and longs pull out anyway.

Meanwhile the turmoil continues – TD pulled its $13.4bn deal for First Horizon, the latter’s shares plunging by a third, the former citing regulatory uncertainty. PacWest tumbled 50% as it explores strategic options including a sale, but was up more than 13% after-hours. Western Alliance shed 38% but rallied 9% after-hours after it denied a report it was considering a potential sale. Wall Street ended lower for a fourth day, the Dow shedding 0.86% to 33,127 and even turning negative for the year.

Regulators Coming Up Short?

Back to the regulators and what they are not doing – the shorts, if they are troublemakers as the regulators see them, are slim lining the banks and making them take action with their balance sheets. What started as deposit flight leading to stock volatility and liquidity crunches has led to the market running against banks that are not really suffering deposit flight - the likes of PacWest and Western Alliance note they have not experienced “unusual deposit flows following the sale of First Republic”. But the regulators are again part of the problem – they have taken an ad-hoc, make-it-up approach to each bank failure - SVB bailout, Signature executed, FRC gets JPM ‘rescue’...so traders inevitably continue to wonder who is next until a line in the sand is drawn.

The thinking is that the regulators ban short-selling to buy time to come up with some kind of plan to rebuild the industry. There may need to be a ‘whatever it takes’ line in the sand moment – clearly the US authorities haven’t done that – it may be that a ban on shorting bank shares forms part of that. Remember this bank stress is just on being the wrong side of rates, we’ve not even had a recession or full credit cycle.

The Big Apple

Apple beat expectations, though revenues fell for the second quarter in a row. Revs were down 3% year-on-year, but adjust for inflation and it’s way worse. Guidance, though not formal, for the June quarter was for growth to be similar to the March quarter...so down 3% again...kinda weak. Mac sales –31% and iPads –13% reflects macro and “very difficult” comparison with the M1 MacBook Pro from a year ago, according to CEO Tim Cook. But...all-time high Services revenues up 5.5%, and best-ever March quarter for the iPhone, installed base record high. Still a giant cash machine...only valuations – trades as growth stock when it’s not really in that category anymore. Shares rose in the after-hours market with iPhone sales beating and $90bn for shareholders.

ECB Conundrums Continue

The European Central Bank hiked rates by 25bps and signaled more to come, though no formal guidance on what is next. “The inflation outlook continues to be too high for too long,” the statement said. The ECB also said it would likely stop reinvestments under the Asset Purchase Program (APP) in July, which was seen a bit more hawkish than the low-ball hike. EURUSD moved towards 1.11 yesterday morning but retraced back under 1.10 after the ECB and is holding around 1.1030 this morning. German factory orders slumped 10% in March from February – much worse than expected, which confirms the sense that the ECB is as much worried about growth and the lag effects of rates as it is about inflation.

Elsewhere in the Markets Today

This morning, European indices traded mainly higher by around half a percent, following a mixed bag in Asia overnight and another tough day for Wall Street. The S&P 500 declined another 0.7% to 4,061 and is offside by 2.6% for the week. European indices are heading for a weekly loss of somewhere north of 1%. Sterling is pushing up for a third day, with GBPUSD rising above 1.26 to its highest since April 2022. USDJPY also faltering with the yen holding big gains for the week; DXY not making new lows with the euro off its highs following the ECB. Spot WTI heading its head on the $70 resistance for a second day, gold weaker at $2,040, about $38 below the Wednesday peak.

Nonfarm payrolls later – seen at +181k, slowing from the +236k last time fewest since 2020, with unemployment steady at 3.6% and wage growth at +0.3%. Bad news is good news – whatever, the Fed is not going to cut in July whatever the futures markets say – it doesn’t matter what the number is today, the Fed is not cutting this year let alone in the summer (unless there is some kind of mega financial crisis, which would be bad for risk assets) but the market will react to that and there is the trade.