The new Regulation SHO will take effect on January 3, 2005. The initial change will be a test incorporating only a select list of equities. After the initial test, the rule will apply to all equities. For those who are new to this concept, short selling is the process of selling stocks that you do not own. Three conditions must be met for this to occur. First, the stock must be borrowed from a current owner. Second, you must have a margin account. Third, the stock must be on an uptick (going up in price). The new Regulation SHO will eliminate the uptick requirement.
The U. S. financial industry cannot compete under the existing market regulations. The uptick requirement helped to create the hedge fund industry, as money managers devised a way to sell stocks short when needed. John Templeton led the pack by moving to the Bahamas in the 1950's. Jim Rogers and George Soros created the Quantum fund, which was one of the most famous hedge funds. Many major U. S. stocks are traded on foreign stock exchanges, which have no uptick rule.
The next problem is market efficiency. The stock market no longer reflects the economy. The counterproductive efforts to prop up the stock market have to change. John Templeton recently stated ,"The stock market is broken." Removing the uptick rule is a beginning in the return to a stock market that represents economic reality. The U. S. cannot hope to attract foreign investors if the valuation is distorted. There are many foreign markets that use economic reality in pricing their markets. Those markets will attract the capital. The U.S. is no longer the only game in town.
Current valuations of the stock market reflect some 60 years of political and economic manipulation. "Pump Priming" must end when the well is dry. The financial community is totally aware of this situation. The more astute of the financial community have demanded the removal of the uptick rule. The people that are influential enough to force policy changes want the option to sell short. Foreign money managers will demand the option of selling short if we want their capital. These selfish creatures are under the assumption that they are in the business of making money with their investments. They will only invest where they have highest probability of success.
The biggest change is information technology. Information can no longer be controlled, monopolized, and reinterperetated at the whim of intellectuals and bureaucrats without the citizenry becoming aware. Social engineering is finished. The opportunity to find any information we need to enrich and improve our lives now exists. This new technology allows one to be aware of the opportunities and restrictions that other nations have created. The international financial community quickly penalizes any country that places investors at a disadvantage. The punishment is the simple refusal to invest in that country.
It might be wise to check our premises at this juncture. How much overvaluation is present in the U.S. equity markets? Major policy shifts usually denote major changes in the environment. To quote Bobby Dylan, "The Times, They Are A-changing"
Wayne N. Krautkramer