The indices stumbled in the final hour of trading and ended up finishing around flat, but there was some interesting, very interesting trading under the surface. Breadth was slightly positive, and we had some strength in commodities, solar energy, chips and gold, while oil, energy and financials lagged.
Some of the high-beta big-cap names that stumbled last Thursday and bounced back a bit on Friday rolled back over again today. Names like PCLN, CRM, WMW, FFIV and NTAP are losing or have lost their momentum. That is not a promising development.
On the other hand, there was some very aggressive momentum trading of solar energy and small-cap China stocks today. It was interesting to see the hot money move from "glamour" names to some low-quality secondary names. In the world of trading, the key is to stick with what is working, and what was working was names that won't ever be considered blue chip.
With the indices churning, more weakness in local leadership and high levels of speculation in junk stocks, the bears can argue that we are a bit late in the run. Consider also that according to Telechart, 86% of stocks are above their 40-day moving average. That is above where we topped out in April and is an area where further upside always becomes more challenging.
The major indices still haven't done anything wrong. There are some warning signs we need to monitor, but until the S&P500 slips back under 1150, I'm not going to be too bearish.
Monday, October 11, 2010
Friday, October 8, 2010
Thoughts
Bond prices are softening, and yields are starting to rise a bit as stocks flat line.
Just because stocks are undervalued relative bonds, that doesn't mean they're cheap.
Where it stops and if it stops, no one can know for sure. 1.) Just because stocks are undervalued relative to bonds - doesn't mean that stocks are cheap, and 2.) quantitative wheezing is not the panacea for the domestic econmy's structural issues.
Just like in 2007-08, we have embarked upon a slippery slope - both economically and in our capital markets.
Sources call the Microsoft/Adobe talk nonsense.
Upside for Mortgage Insurers?
No more foreclosures could mean a ramp for these stocks.
The mortgage insurers should ramp higher after BAC announced that is putting in a nationwide moratorium on foreclosures.
Of concern was the continued drop in government jobs (even adjusted for the 77,000 Census workers lost) and the flat read in average hourly earnings and average weekly hours.
The report reinforces the likelihood of another round of quantitative easing being implemented in early November.
Bullard Beats Around the Bush on QE 2
St. Louis Fed President James Bullard previously indicated that the Fed was ready to make a QE 2 move if needed.
This morning, he appeared to move off that position slightly.
St. Louis Federal Reserve President James Bullard has previously given an indication to the markets that if the situation warranted QE 2, the Fed was ready to act on it.
Based on the recent advance, the markets certainly seem to be assigning a high probability to a Nov. 2-3 QE 2 announcement.
This morning, he appeared to move off that position slightly.
The risk of double-dip recession has probably receded some in last the six to eight weeks. The economy has slowed, but it hasn't slowed so much that it's an obvious case to do something. A very reasonable decision would be to say, "Maybe we should push it off a meeting or two and see how the data comes in."
-- James Bullard (CNBC interview)
That stated, it's coming anyway at the November Fed meeting.
Just because stocks are undervalued relative bonds, that doesn't mean they're cheap.
Where it stops and if it stops, no one can know for sure. 1.) Just because stocks are undervalued relative to bonds - doesn't mean that stocks are cheap, and 2.) quantitative wheezing is not the panacea for the domestic econmy's structural issues.
Just like in 2007-08, we have embarked upon a slippery slope - both economically and in our capital markets.
Sources call the Microsoft/Adobe talk nonsense.
Upside for Mortgage Insurers?
No more foreclosures could mean a ramp for these stocks.
The mortgage insurers should ramp higher after BAC announced that is putting in a nationwide moratorium on foreclosures.
Of concern was the continued drop in government jobs (even adjusted for the 77,000 Census workers lost) and the flat read in average hourly earnings and average weekly hours.
The report reinforces the likelihood of another round of quantitative easing being implemented in early November.
Bullard Beats Around the Bush on QE 2
St. Louis Fed President James Bullard previously indicated that the Fed was ready to make a QE 2 move if needed.
This morning, he appeared to move off that position slightly.
St. Louis Federal Reserve President James Bullard has previously given an indication to the markets that if the situation warranted QE 2, the Fed was ready to act on it.
Based on the recent advance, the markets certainly seem to be assigning a high probability to a Nov. 2-3 QE 2 announcement.
This morning, he appeared to move off that position slightly.
The risk of double-dip recession has probably receded some in last the six to eight weeks. The economy has slowed, but it hasn't slowed so much that it's an obvious case to do something. A very reasonable decision would be to say, "Maybe we should push it off a meeting or two and see how the data comes in."
-- James Bullard (CNBC interview)
That stated, it's coming anyway at the November Fed meeting.
Thoughts On Foreclosures
I think we are double counting foreclosures and delinquencies. The accounting and recordkeeping for mortgages is a global disaster. I am hearing/seeing this from various legal real estate people.
How do we deal with this? Maybe we should just draw a line in the sand. By June 30, 2011, say, if you cannot prove that you hold a mortgage, then you don't. Maybe some people walk away scot-free. Most of these mortgages are already written down to near zero. At the end of the day, we might benefit the no-good-niks along with the truly needy. At least, we will know what the true housing inventory is and what is not.
Want to know why the market likes today's labor report? It may not be because of QE II. Isn't QEII being over-analyzed? Over-anticipated? Overvalued? Maybe it's because the Obama Administration is in Titanic-like trouble for the elections. The administration, other than jacking up the government payroll, has done very little with the Keynesian spending it threw around like drunken sailors on shore leave in Thailand.
If we are producing any jobs, it is off the books. As a result, we will have a tax-less recovery. People are going to work off the books, not paying payroll or income taxes.....
How do we deal with this? Maybe we should just draw a line in the sand. By June 30, 2011, say, if you cannot prove that you hold a mortgage, then you don't. Maybe some people walk away scot-free. Most of these mortgages are already written down to near zero. At the end of the day, we might benefit the no-good-niks along with the truly needy. At least, we will know what the true housing inventory is and what is not.
Want to know why the market likes today's labor report? It may not be because of QE II. Isn't QEII being over-analyzed? Over-anticipated? Overvalued? Maybe it's because the Obama Administration is in Titanic-like trouble for the elections. The administration, other than jacking up the government payroll, has done very little with the Keynesian spending it threw around like drunken sailors on shore leave in Thailand.
If we are producing any jobs, it is off the books. As a result, we will have a tax-less recovery. People are going to work off the books, not paying payroll or income taxes.....
Market Ignores Jobs Data; Looking At/For QEII???
After a brief stumble in the opening minutes, the market action turned upbeat and unworried. The buyers wanted in, and there was no hint at all in the action that we had just come off of another lousy jobs report.
We just happen to be in one of those perverse periods when bad news is good news because it means that the Fed is likely to continue to manipulate the market higher. Poor jobs news probably also helps bolster the chances of a Republican victory in November, and that would give the market the political gridlock it tends to prefer.
This market action really demands that you set aside logic and common sense and embrace the idea that you just can't fight the Fed in the short term, no matter how wrong its policies appear to be. QE 2 is practically a done deal at this point.
The stocks that are most likely to benefit from a weaker dollar and QE 2 are oils, agriculture and commodity-related names, and those are what lead the market today. Breadth was solid at close at 3 to 1 positive and volume picked up a bit to give us an accumulation day. Financials, particularly the regional banks, were the weak spot today, but most every other sector was up.
Technically, today was a good follow-through to Tuesday's S&P 500 breakout over 1150. We had the highest close since early May, and there isn't much overhead resistance all the way up to the highs of the year we hit in April.
It certainly is understandable why the bears would be feeling very frustrated by this market. It is being manipulated upward by the Fed, and whatever is happening in the real economy just doesn't matter very much. There are a lot of folks holding their noses and buying, and that is keeping the momentum going. At some point, the Fed games will come to an end and the market will pay a price for what it is enjoying now, but today isn't the day, and it's possible that the day won't come for a while.
Earnings season picks up next week, so we'll have some relief from the macro-economic focus. Expectations have been rising along with the market, so the potential for surprise is high.
We just happen to be in one of those perverse periods when bad news is good news because it means that the Fed is likely to continue to manipulate the market higher. Poor jobs news probably also helps bolster the chances of a Republican victory in November, and that would give the market the political gridlock it tends to prefer.
This market action really demands that you set aside logic and common sense and embrace the idea that you just can't fight the Fed in the short term, no matter how wrong its policies appear to be. QE 2 is practically a done deal at this point.
The stocks that are most likely to benefit from a weaker dollar and QE 2 are oils, agriculture and commodity-related names, and those are what lead the market today. Breadth was solid at close at 3 to 1 positive and volume picked up a bit to give us an accumulation day. Financials, particularly the regional banks, were the weak spot today, but most every other sector was up.
Technically, today was a good follow-through to Tuesday's S&P 500 breakout over 1150. We had the highest close since early May, and there isn't much overhead resistance all the way up to the highs of the year we hit in April.
It certainly is understandable why the bears would be feeling very frustrated by this market. It is being manipulated upward by the Fed, and whatever is happening in the real economy just doesn't matter very much. There are a lot of folks holding their noses and buying, and that is keeping the momentum going. At some point, the Fed games will come to an end and the market will pay a price for what it is enjoying now, but today isn't the day, and it's possible that the day won't come for a while.
Earnings season picks up next week, so we'll have some relief from the macro-economic focus. Expectations have been rising along with the market, so the potential for surprise is high.
Thursday, October 7, 2010
Thoughts
My guess is that the MSFT/ADBE takeover story is nonsense.
If it were true, I suspect MSFT's shares would have been schmeissed -- they were not.
Not So Fast on No QE 2
Considering Fisher's track record, however, it is likely that QE 2 is still very much an early-November event.
It should be noted, however, that Fisher has been materially wrong in his economic forecasting.
For example, he publicly suggested tightening in early 2008!
So, QE 2 is still very much an early-November event, as indicated by Bernanke, Dudley, "Sad" Sack and Evans.
Dallas Fed President Fisher says that further easing 'is not a done deal.'
Dallas Fed President Fisher is on Bloomberg saying that he hasn't made his mind up on further easing -- the markets has jumped too quickly to a conclusion.
Further easing, "is not a done deal."
Run, don't walk, to read some cautionary remarks from Gallup on September unemployment.
The Truth and Consequences of QE 2
This levitation of asset prices has unintended negative consequences.
I have been questioning the ultimate efficacy of a likely November QE 2 in a series of "quantitative wheezing" columns.
Stated simply, the first round of quantitative easing produced "shock and awe," but QE 2 will likely produce "shucks and aww."
From my perch, QE 2 will not meaningfully move the needle of domestic economic growth and will only have a limited impact on:
* the jobs market (we have structural unemployment);
* on housing (we will be continued to be haunted by a large shadow inventory of unsold homes); and
* on confidence (we are still mired in uncertainty regarding regulatory and tax policy).
Meanwhile, our fiscal imbalances multiply, and our currency craters (and a worldwide rush to currency devaluation offsets some of the normal trade deficit benefit). Plus, there are a number of other possible adverse consequences from the inefficient allocation of resources that is the outgrowth of the next tranche of monetary stimulation.
On Tuesday, the New York Fed's Sack anticipates that QE 2 will likely elevate asset prices above where they would be without it.
This levitation of asset prices has unintended negative consequences, too.
Just look at the $35-a-share loss in EQIX's share price yesterday, even though there was only a 1.5% sales miss, while earnings before interest, taxes, depreciation and amortization was above expectations.
Under the backdrop of the salutary impact of QE 2, the sharp rise in Equinix's shares (and many other high-octane stocks) created a speculative and what now appears to have been an unjustified rise founded in hype and an excessive valuation.
So, the bottom falls out of the shares (as witnessed yesterday) on the slightest disappointment.
Riddle me this: How does this Fed-induced bubble and bursting stock action buoy our economy, turn around our jobs market or make investors more confident?
Answer: It doesn't.
If it were true, I suspect MSFT's shares would have been schmeissed -- they were not.
Not So Fast on No QE 2
Considering Fisher's track record, however, it is likely that QE 2 is still very much an early-November event.
It should be noted, however, that Fisher has been materially wrong in his economic forecasting.
For example, he publicly suggested tightening in early 2008!
So, QE 2 is still very much an early-November event, as indicated by Bernanke, Dudley, "Sad" Sack and Evans.
Dallas Fed President Fisher says that further easing 'is not a done deal.'
Dallas Fed President Fisher is on Bloomberg saying that he hasn't made his mind up on further easing -- the markets has jumped too quickly to a conclusion.
Further easing, "is not a done deal."
Run, don't walk, to read some cautionary remarks from Gallup on September unemployment.
The Truth and Consequences of QE 2
This levitation of asset prices has unintended negative consequences.
I have been questioning the ultimate efficacy of a likely November QE 2 in a series of "quantitative wheezing" columns.
Stated simply, the first round of quantitative easing produced "shock and awe," but QE 2 will likely produce "shucks and aww."
From my perch, QE 2 will not meaningfully move the needle of domestic economic growth and will only have a limited impact on:
* the jobs market (we have structural unemployment);
* on housing (we will be continued to be haunted by a large shadow inventory of unsold homes); and
* on confidence (we are still mired in uncertainty regarding regulatory and tax policy).
Meanwhile, our fiscal imbalances multiply, and our currency craters (and a worldwide rush to currency devaluation offsets some of the normal trade deficit benefit). Plus, there are a number of other possible adverse consequences from the inefficient allocation of resources that is the outgrowth of the next tranche of monetary stimulation.
On Tuesday, the New York Fed's Sack anticipates that QE 2 will likely elevate asset prices above where they would be without it.
This levitation of asset prices has unintended negative consequences, too.
Just look at the $35-a-share loss in EQIX's share price yesterday, even though there was only a 1.5% sales miss, while earnings before interest, taxes, depreciation and amortization was above expectations.
Under the backdrop of the salutary impact of QE 2, the sharp rise in Equinix's shares (and many other high-octane stocks) created a speculative and what now appears to have been an unjustified rise founded in hype and an excessive valuation.
So, the bottom falls out of the shares (as witnessed yesterday) on the slightest disappointment.
Riddle me this: How does this Fed-induced bubble and bursting stock action buoy our economy, turn around our jobs market or make investors more confident?
Answer: It doesn't.
Volatility Ahead Of The Jobs Report
The good news today was that many of the high-momentum stocks that were clobbered yesterday bounced back after a further dip this morning. We had a roller-coaster day with the opening gap up being sold aggressively but an afternoon bounce that kept losses small.
Breadth wasn't a bit weak, with most major sectors showing minor losses. Semiconductors led to the upside, but gold, oil and commodities names were under pressure. There were some pockets of positive action in retail, but the heavyweights in the group offset the likes of ANF and AEO.
The S&P 500 did manage to hold the 1150 area after a near test, and that is a positive sign. Overall, it was just quite a bit of churning and back-and-forth action as we await the jobs numbers in the morning. Once we are past that, we can start to focus more on third-quarter earnings, which should make for much more interesting trading.
We will need to be especially carefully tomorrow on the jobs numbers. Not only do we have the usual difficulty of trying to determine expectations, we have the added possibility that bad numbers may be a market positive and good numbers may be a negative.
Breadth wasn't a bit weak, with most major sectors showing minor losses. Semiconductors led to the upside, but gold, oil and commodities names were under pressure. There were some pockets of positive action in retail, but the heavyweights in the group offset the likes of ANF and AEO.
The S&P 500 did manage to hold the 1150 area after a near test, and that is a positive sign. Overall, it was just quite a bit of churning and back-and-forth action as we await the jobs numbers in the morning. Once we are past that, we can start to focus more on third-quarter earnings, which should make for much more interesting trading.
We will need to be especially carefully tomorrow on the jobs numbers. Not only do we have the usual difficulty of trying to determine expectations, we have the added possibility that bad numbers may be a market positive and good numbers may be a negative.
ETFs
Like many innovations in finance that emerge from nowhere to explode in popularity with unknown consequences, exchange-traded funds have gone from obscurity when they were first invented in 1993 to making up more than half of all the daily trading volume on American stock exchanges today. They also made up 70% of all the canceled trades during the Flash Crash on May 6, despite representing just 11% of listed securities in the United States, suggesting that ETFs remain poorly understood by both investors and regulators.
The extraordinary popularity of exchange-traded funds, open-ended mutual funds that trade like stocks on an exchange, is undeniable. However, the source of this popularity would seem to have two very different origins. ETFs are bought by many retail and institutional investors looking for low cost and highly liquid vehicles with which to buy whole indices in a single trade, and ETFs serve that noble function well. But, they are also extremely popular with and widely used by hedge funds and other traders looking for a simple way to mitigate broad-market risks, or neutralize beta, with a single trade. The appeal to a hedge fund manager of being able to short an entire market index or a whole sector with one transaction, instead of say 500 separate stock shorts to span the S&P 500 Index, makes ETFs very widely used as hedging vehicles by short-sellers. It increasingly looks like many new ETFs are now being designed for the purpose of marketing them to short-sellers.
These seemingly opposite interests in ETFs make for a large and lucrative market not just for the ETF operators like BlackRock’s iShares and State Street Global Advisors SPDRs, but also for the authorized participants–institutions that can create or redeem large blocks of new shares in an ETF (called creation units) for sale, and countless brokers that profit by trading ETF shares.
While ETFs often appear to be a benign innovation as compared to some of Wall Street’s arcane derivatives, a closer look at the mechanics of short selling ETFs (which have become one of the most prevalent securities to short) raises some serious concerns. While an ETF owner believes their ETF shares represent ownership of the underlying shares of stock in the index that the ETF tracks, that stock is not always all there. Because of explosive short interest in some ETFs, owners of ETF shares often far outnumber the actual ownership of the underlying index equities by the ETF operator. One might ask how that can be possible, but the creation and redemption mechanisms inherent to ETFs mean that short sellers need not be concerned about the availability of shares outstanding when they sell an ETF short—since they can always create new shares using creation units to cover short positions in ETFs in the future. In essence, there appears to be no risk to being naked short an ETF since the short seller can always “create to cover”. This has led to some ETFs having shockingly large short interest as compared to their number of shares outstanding and for every additional ETF share sold short, there is another owner of that share.
Take the SPDR S&P Retail ETF - XRT - as an example. The number of shares short was nearly 95 million at the end of June, while the shares outstanding of the ETF were just 17 million. The ETF was over 500% net short! Or to look at it from another perspective, the ETF’s operator, State Street Global Advisors, believed that there were 17 million shares of the SPDR S&P Retail ETF in existence and owned shares in the S&P Retail Index portfolio to underlie those 17 million ETF shares. But, in the marketplace there were another 95 million shares of the ETF owned by investors who had purchased them (unknowingly) from short sellers. 78 million of those ETF shares were naked short–the short seller had promised their prime broker to create those non-existent shares if necessary to cover their short in the future. In both cases the share buyer, however, is completely unaware his ETF shares were purchased from a short-seller and no doubt assumes the underlying assets in the index are being held by the ETF operator on his behalf, but no such underlying stock is actually held by anyone. Clearly this creates a serious counterparty risk and quite possibly the potential for a run on an ETF—where the assets held by the fund operator could become insufficient to meet redemptions.
Even more alarming was the recent rate of redemptions from the SPDR S&P Retail ETF in July and August 2010. Redemptions occur when more owners wish to sell out of their holding in the ETF than there are new buyers for the existing shares, so unwanted blocks of 50,000 ETF shares each are redeemed through the authorized participants with the ETF operator for cash, or more typically for in-kind shares in the ETF’s underlying index’s stocks. The SDPR S&P Retail ETF was one of the fastest contracting ETFs in July due to redemptions and as of July 31, it had just 7 million shares outstanding. However, the short interest was little changed—still over 80 million shares short. Suddenly, 11 times the number of shares outstanding was short, which is even more worrisome than 5 times back in June. By late August, the shares outstanding in XRT had dipped briefly below 5 million shares with 80 million shares still short (16 times the shares outstanding). Mercifully, net buying interest has rebounded somewhat for the SDPR S&P Retail ETF with the improving outlook for retailers and shares outstanding in XRT had rebounded to 12 million by mid-September. But if the rate of contraction last month had continued, the ETF was just days away from running out of underlying shares altogether.
So what happens if the recent monthly redemption rates return and 15 million more shares in the ETF were redeemed by the end of this month? Presumably the SPDR S&P Retail ETF would simply close and cease to exist once its remaining 12 million ETF shares outstanding had been redeemed and all its underlying equity holdings had been delivered to redeeming authorized participants. But where does that leave all the ETF owners who unknowingly bought their shares in the ETF from naked short sellers? If the ETF is all out of underlying equities and is essentially shut down, what happens to the remaining owners of the 80 million shares of the ETF? The ETF operator would have no more underlying shares (or cash) in the fund and the ETF would have essentially collapsed since all the shares outstanding were already redeemed. At recent prices the unfunded remaining ownership in the marketplace for which nobody currently owns any shares would be over $3 billion for just this one ETF! Extend this hidden unfunded liability from massive scale short-selling of ETFs (both traditional and naked) across the entire ETF spectrum and it is a $100 billion potential problem.
Who gets left holding the bag? Is it the retail account holders who own defunct shares in a closed ETF? The prime brokers that were counterparties to all those short sellers? The hedge funds that sold non-existent shares in an ETF assuming they could always be created another day? The ETF operator? Or the Federal Reserve?
The extraordinary popularity of exchange-traded funds, open-ended mutual funds that trade like stocks on an exchange, is undeniable. However, the source of this popularity would seem to have two very different origins. ETFs are bought by many retail and institutional investors looking for low cost and highly liquid vehicles with which to buy whole indices in a single trade, and ETFs serve that noble function well. But, they are also extremely popular with and widely used by hedge funds and other traders looking for a simple way to mitigate broad-market risks, or neutralize beta, with a single trade. The appeal to a hedge fund manager of being able to short an entire market index or a whole sector with one transaction, instead of say 500 separate stock shorts to span the S&P 500 Index, makes ETFs very widely used as hedging vehicles by short-sellers. It increasingly looks like many new ETFs are now being designed for the purpose of marketing them to short-sellers.
These seemingly opposite interests in ETFs make for a large and lucrative market not just for the ETF operators like BlackRock’s iShares and State Street Global Advisors SPDRs, but also for the authorized participants–institutions that can create or redeem large blocks of new shares in an ETF (called creation units) for sale, and countless brokers that profit by trading ETF shares.
While ETFs often appear to be a benign innovation as compared to some of Wall Street’s arcane derivatives, a closer look at the mechanics of short selling ETFs (which have become one of the most prevalent securities to short) raises some serious concerns. While an ETF owner believes their ETF shares represent ownership of the underlying shares of stock in the index that the ETF tracks, that stock is not always all there. Because of explosive short interest in some ETFs, owners of ETF shares often far outnumber the actual ownership of the underlying index equities by the ETF operator. One might ask how that can be possible, but the creation and redemption mechanisms inherent to ETFs mean that short sellers need not be concerned about the availability of shares outstanding when they sell an ETF short—since they can always create new shares using creation units to cover short positions in ETFs in the future. In essence, there appears to be no risk to being naked short an ETF since the short seller can always “create to cover”. This has led to some ETFs having shockingly large short interest as compared to their number of shares outstanding and for every additional ETF share sold short, there is another owner of that share.
Take the SPDR S&P Retail ETF - XRT - as an example. The number of shares short was nearly 95 million at the end of June, while the shares outstanding of the ETF were just 17 million. The ETF was over 500% net short! Or to look at it from another perspective, the ETF’s operator, State Street Global Advisors, believed that there were 17 million shares of the SPDR S&P Retail ETF in existence and owned shares in the S&P Retail Index portfolio to underlie those 17 million ETF shares. But, in the marketplace there were another 95 million shares of the ETF owned by investors who had purchased them (unknowingly) from short sellers. 78 million of those ETF shares were naked short–the short seller had promised their prime broker to create those non-existent shares if necessary to cover their short in the future. In both cases the share buyer, however, is completely unaware his ETF shares were purchased from a short-seller and no doubt assumes the underlying assets in the index are being held by the ETF operator on his behalf, but no such underlying stock is actually held by anyone. Clearly this creates a serious counterparty risk and quite possibly the potential for a run on an ETF—where the assets held by the fund operator could become insufficient to meet redemptions.
Even more alarming was the recent rate of redemptions from the SPDR S&P Retail ETF in July and August 2010. Redemptions occur when more owners wish to sell out of their holding in the ETF than there are new buyers for the existing shares, so unwanted blocks of 50,000 ETF shares each are redeemed through the authorized participants with the ETF operator for cash, or more typically for in-kind shares in the ETF’s underlying index’s stocks. The SDPR S&P Retail ETF was one of the fastest contracting ETFs in July due to redemptions and as of July 31, it had just 7 million shares outstanding. However, the short interest was little changed—still over 80 million shares short. Suddenly, 11 times the number of shares outstanding was short, which is even more worrisome than 5 times back in June. By late August, the shares outstanding in XRT had dipped briefly below 5 million shares with 80 million shares still short (16 times the shares outstanding). Mercifully, net buying interest has rebounded somewhat for the SDPR S&P Retail ETF with the improving outlook for retailers and shares outstanding in XRT had rebounded to 12 million by mid-September. But if the rate of contraction last month had continued, the ETF was just days away from running out of underlying shares altogether.
So what happens if the recent monthly redemption rates return and 15 million more shares in the ETF were redeemed by the end of this month? Presumably the SPDR S&P Retail ETF would simply close and cease to exist once its remaining 12 million ETF shares outstanding had been redeemed and all its underlying equity holdings had been delivered to redeeming authorized participants. But where does that leave all the ETF owners who unknowingly bought their shares in the ETF from naked short sellers? If the ETF is all out of underlying equities and is essentially shut down, what happens to the remaining owners of the 80 million shares of the ETF? The ETF operator would have no more underlying shares (or cash) in the fund and the ETF would have essentially collapsed since all the shares outstanding were already redeemed. At recent prices the unfunded remaining ownership in the marketplace for which nobody currently owns any shares would be over $3 billion for just this one ETF! Extend this hidden unfunded liability from massive scale short-selling of ETFs (both traditional and naked) across the entire ETF spectrum and it is a $100 billion potential problem.
Who gets left holding the bag? Is it the retail account holders who own defunct shares in a closed ETF? The prime brokers that were counterparties to all those short sellers? The hedge funds that sold non-existent shares in an ETF assuming they could always be created another day? The ETF operator? Or the Federal Reserve?
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