The markets are enjoying a nice rally today likely spurred on by Citigroup’s comment that they were profitable during the first two months of the quarter. Bank of America, JP Morgan and Wells Fargo made similar comments in recent days, but only Citigroup’s comments have had the power to move the markets up as they are doing today.
Barnie Frank’s comments that Congress would reinstate the up tick rule for short sales within the month and review mark to market rules may also be causing a little anxiety for the market’s short sellers. As a sign of how prevalent and mainstream short selling has become, a friend of a coworker recently told him he was considering purchase of “some stock” that had done well this year. Eager to know what this stock was, my coworker looked it up and discovered that it was an exchange traded fund that was short banking and financial stocks and leveraged three to one.
This is yet another example of fund flows going wild, similar to what happened with tech stocks and housing stocks, but this time in reverse. As we’ve discussed ad nauseum, when an area of the markets do well, people want a piece of it. Fund flows go gaga and the stocks in the area surge even further as cash pushes the price ever upwards.
The combination of successful short selling strategies in the past year and the ease of access to vehicles like exchange traded funds that are short various areas of the market are proving to be a combustible mix. To make matters even more absurd, many of these vehicles are leveraged 3X. It’s shocking that this is occurring in spite of what we’re learned about leverage in recent months. Of course, it would be easy to say buyer beware, but if there is anything that the past two years have taught me, it’s that excessive leverage can create toxic secondhand smoke, obliterating not only the user but possibly many innocent bystanders along the way.
I just can’t understand why our regulators aren’t looking into this situation. It may be one thing to put your own funds at risk, but doing the same thing in triple X fashion with other people’s money is pornographic, plain and simple.