Sunday, August 28, 2011

In a subjunctive state of mind

Used primarily in modern times to provide the emotional underpinnings of boleros and Johnny Hartman ballads, the subjunctive mood fell into near total disuse in the English language over the course of the twentieth century. One of the regrettable results of this loss of communicative precision is that it has become seductively and irresistibly easy to present purely hypothetical proofs as if they were factual. Had it never taken place the human race might have ended up not being subjected to an unending barrage of contrafactual non-events posing as evidence supporting various indisputable tenets of finance and economics.

The uproar raised by the folks pictured above when, on August 12th, a number of eurozone countries temporarily banned the short sale of financial stocks and derivatives provides a pertinent example. The Millionth Monkey puts it best:

There are those who say the upcoming short selling ban in all stocks in Italy and France, which according to CNBC will take place as soon as after the close today, or in one hour, will be beneficial to stocks. Then there are facts. To those who may have forgotten, on September 18 (ed. 2008), the SEC banned the shorting of all financials here in the US. Below is a chart of the carnage that ensued... The same chart is coming to Europe first. End result: 48% drop in under a month.

Lacking the grammatical tools necessary for the task, what the intellectually challenged (and incredibly confused about the temporal order in which arguments are presented) writer of that piece is attempting to claim is that if the SEC were not to have banned short sales on financials three years ago that the outcome with respect to US banking stocks would not have been materially different. It’s that simple – the SEC kicked out the hyperthyroidic short specs and the market crashed anyway. Kindly, for its part, nature has recently provided us with a second opinion on that relationship – the Europe to which their chart is ‘coming to’.

Assuming, correctly we believe, that the effect of the directive can be measured from the moment that the rumour mill declared it a done deal and the shorts started covering in earnest – the lows of August 11th – the following lists the performance of various Eurostoxx banks affected by the ban through this Friday’s close.

Santander - +8.5%
BBVA - +6.9%
BNP Paribas - +2%
Credit Agricole - +10%
Intesa - +5%
Societe Generale - +6%
Unicredit - +1%

German Banks, however, were not subjected to the indignity of a prohibition.

Deutsche Bank - -3%
Commerzbank - 0%

We’ll take all this resultant calmness in the market as an incipient proof of the point we made the day after the ban was implemented – that the short position statistics, at least in the case of Spanish banks, indicated that ‘real’ money was not participating in the sell-off. Under circumstances like these, in other words, the strategy works.

Had the ban not been implemented, and were the banks to have ceased to fall further regardless, then the other possibility would have been that the market authorities have entered into the game of market timing by hiring a CTA to bolster their staff. The chart on the left shows the Eurostoxx 50 support level at which the intervention was effected.

Nice play, guys.



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