“The claim that short selling also removes bubbles might be a bubble… ”

The controversy over short selling is on fire again
Did short selling show its net function?
Did short selling foam removal work?

Short selling, which is called the grave of ants, is again at the center of controversy. The market’s opinions are diverging ahead of the expiration date of the ban on short selling on March 15. Individual investors insist that improving the short selling system, which is a’tilted playground’, should precede. The opinions demanding the resumption of short selling are also difficult. This is because the proper’price discovery function’, which is the net function of short selling, must be activated to prevent the market from bubbling. The SCOOP reported on the controversy over the short selling that was on fire again.

Short selling is an investment strategy that makes a profit by borrowing the stock of the stock when the stock price is expected to fall, selling it in advance, and repaying the stock borrowed with the stock purchased at a lower price if the stock price actually falls. Such short selling has recently emerged as a hot issue. This is because opinions advocating for the resumption of short selling and the extension of the short selling ban ahead of the expiration of the short selling ban scheduled for March 15th are mixed.

In particular, the backlash from individual investors who greatly contributed to creating the KOSPI index of 3100 points is strong. It is because of the concern that if they resume short selling, they will lose money. Even in the political world, it is dangerous to resume short selling. It is for this reason that the financial authorities, which said they would resume short selling on March 16, stepped back, saying, “Please wait.”

Finance Commissioner Eun Seong-soo said at a briefing on the ‘2021 Business Plan’ on the 18th. “Short selling has been and will be decided by a meeting of the Financial Services Commission consisting of nine people. Please understand that it is impossible to say whether or not to resume short selling. Nothing is being discussed with political parties such as the ruling party. When the regular National Assembly is held in February, I think it will be a listening process to discuss or give an opinion.”

Perhaps that is why the pros and cons surrounding short selling extension and resumption are still running parallel. Those who oppose short selling raise their voices that the short selling market is a’sloping playground’. In fact, the proportion of short sale transactions recorded by institutional and foreign investors in the KOSPI market in 2019 recorded 40.07% and 59.09%, respectively. That means 99.16% of short selling transactions were accounted for by the two forces. This is the reason why there is a complaining that ants are forced to be helpless in short selling, which is the exclusive property of institutions and foreigners.

Some analysis shows that the return on investment from short selling is much higher than that of credit transactions invested by individuals with money borrowed from securities companies. According to the thesis “Investment Performance of Short Selling and Credit Transactions” published by Dr. Eun-Ha Lim and Professor Sang-Kyung Jeon of Hanyang University (Business Administration), the short selling force generated 9175 billion won from June 30, 2016 to June 28, 2019. . This is more than 39 times the amount of 23.3 billion won in income earned by individuals through credit transactions.

“Only foreign investors and some institutions are making money through short selling,” said Eui-jeong Eui-jung, president of the Korea Stock Investors Association. Conversely, those who favor short selling argue that “short selling cannot be viewed as a factor that drives down the stock price.” Professor Bin Ki-beom of Myongji University (economics) said, “There is nothing revealed about the impact of short selling on the stock market. It is only a hypothesis that the stock price fell due to short selling and that the stock price rose because short selling was prohibited.”

Some believe that it is the fundamentals of the company that determine the stock price, not short selling. Kyobo Securities Research Center head Kim Hyung-ryul advised, “Short selling cannot affect or damage the value of a company.” He advised, “We must consider how to prevent unfair transactions such as non-borrowing short selling rather than the existence of short selling.”

Some proponents also emphasize the net function of short selling, the’price discovery function’. It has the ability to find the right price of overvalued stocks and remove bubbles from stock prices. If so, did the net function of short selling, such as finding the right price and removing bubbles, actually work? If so, short selling should have been made around highly valued stocks. This is the reason why Thescoop analyzed the top short selling stocks in 2019.

Banning short selling ahead of the end

According to the Korea Exchange, Netmarble, S-Oil, and Hanon Systems were listed among the top three short selling stocks in 2019. The price-earnings ratio (PER) or stock price-net asset ratio (PBR) was used to determine whether a stock was overvalued or not. If both indices are higher than the industry average, the stock price can be considered overvalued.

The stock price of Netmarble (19.82% of short selling), which was in the 120,000 won range in May 2019, began to decline sharply at the end of June, and dropped to 8,100 won on August 6 of that year. This coincides with the period during which short selling was concentrated. At the time, there was an analysis that the success of the new game was unexpectedly unpredictable, but the performance steadily increased. In 2019, Netmarble’s PER was 50.68x, higher than the industry average of 41.19x, but its PBR was 1.7x, lower than the industry average of 2.56x. As seen in the PER and PBR, it was difficult to say that the stock price had a bubble.

This is because the stock price, which was around 180,000 won in early 2018, continued to decline. The factor that shook the stock price at the time was the news that Netmarble’s acquisition of Nexon, which was known on June 26, 2019, was broken. This means that the short selling forces made money by using short-term issues. It seems far from the price discovery function, which is the net function of short selling.

Hanon Systems was sick with short selling in early 2019. The stock price of Hanon Systems, which makes air conditioning systems, a key component of electric vehicles, climbed in anticipation that the electric vehicle market could grow in early 2019. The stock price rose 30.1% (2940 won) from 9760 won on December 11, 2018 to 12,700 won on January 21, 2019. Interestingly, short selling and selling prices were concentrated during this period. However, the short selling price discovery feature did not work. This is because the stock price rose despite the short selling trend.

This is proof that the market price suggested by the short selling forces is not always correct. Even Hanon Systems’ 2019 PER and PBR were 18.69x and 2.68x, respectively, higher than the industry average of 15.80x and PBR of 1.10x.

Of course, there are cases in which the net function of short selling, called’price discovery’, worked. S-Oil (19.03% of short selling) is a representative example. The company’s stock price from 106,000 won on October 25, 2019 fell 16.8% to 8,100 won on December 4 of that year. This is because profitability has deteriorated sharply due to the fall in oil prices in 2019. S-OIL’s net profit for the third quarter of 2019 was 51.5 billion won, down 77.5% from the same period last year (229.8 billion won).

In 2019, S-OIL’s PER and PBR were 169.84x and 1.71x, respectively, more than twice the average of the industry (PER 52.81x and PBR 0.84x). It is the result of reflecting the net function of short selling to find an appropriate price by quickly reflecting negative information on the stock price.

Resumption of short selling

You don’t have to worry too much about the negative effects of short selling, but you don’t need to overemphasize your net function. Right now, it may be necessary to correct the slanted short selling system. Listen to Jeong Yong-taek, head of IBK Investment & Securities Research Center. “It is correct that short selling is a necessary system because it removes bubbles in the stock price. However, short selling is also an investor’s choice, so don’t think that it always moves reasonably. The reason short selling is controversial is that foreign investors and institutional investors are free to trade short selling, but only individual investors are restricted. There is a need to improve the short selling system, which is disadvantageous to individual investors.” This seems to be something the government officials in charge of short selling should listen to.

Seo-gu Kang, reporter
[email protected]

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