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2005
Outlook |
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There is a raging debate amongst
technicians concerning the long term nature of our current market. In 2003
we enjoyed a strong snap back rally after the worst three year bear market
since the crash of '29. 2004 was lackluster in comparison. The 4th quarter
rally saved the day, but in an anemic manner. The NASDAQ made a high of
2153 in January, and didn't eclipse that high until the last trading week
of the year, closing at 2175. A trifling 22 point move from the January
peak. The other 11 months the market was selling off and recouping its
losses. Hardly a raging bull market, even though it seemed pretty good
in December. If it feels like a lot of your stocks spent the year grinding
sideways, it's because they did.
Technicians are evenly divided on
2005. Many feel the 2003 to 2004 was simply a relief rally in a long term
secular bear market, citing a falling dollar, high oil, deficit spending,
rising interest rates, and decelerating earnings. Others feel the sideways
grinding throughout 2004 set us up for a strong rally in 2005, arguing
a falling dollar, little evidence of inflation, and a healthy economy will
bolster 2005.
Ever the eternal optimist, I am in
the bullish camp. Supporting the bullish contingent is the S&P mid
cap and the Russell 2000, both of which made all time highs near year's
end. When you have indexes trading at all time highs, it is tough to make
an argument for a Bear Market.
2005 will be characterized by another
year of moderate growth. Small caps will continue to outperform large caps
as they are simply growing faster, and therefore the market will pay its
normal premium for growth. Large cap dollars should be in dividend paying
stocks, as I believe dividends will become an important component of total
return.
I am going to exercise my right to
withhold final judgment on the bull or bear argument. At the end of December
many of the indexes butted up against long term resistance. We are now
in a post Santa Claus rally pullback. Breakouts above December highs in
the next leg up will confirm the bullish thesis. A series of lower highs
would be highly unfavorable.
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Regulation SHO:
This Could Get Interesting |
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The OTC Journal archives reveal
I have written three editions on the subject of illegal naked short selling
over the past two years. It is a fascinating subject, and one that is back
in the news as a new SEC regulation goes into effect this week.
If you have an interest in this subject
and want to review the past editions, here they are: 4/19/03,5/18/03,
and
2/4/04.
Illegal naked short selling has been
problematic for microcap stocks for many years, but the pendulum began
to swing the other way in early 2004. Normal short selling requires the
seller to borrow the shares ahead of executing a sell trade in shares not
owned. The seller hopes to buy them back later at a lower price and lock
in a profit.
For many years short sellers have
been able to simply sell unlimited supplies of small stocks through overseas
brokerage firms, even though no shares have been borrowed. Thanks to loopholes
in the clearing system, these sellers are never forced to deliver the shares.
In essence, short sellers have been able to "counterfeit" supplies of stock
by avoiding the regulations from offshore.
Small and microcap companies have
been particularly vulnerable to this practice as there is often little
institutional support for the stocks. When a stock starts trading poorly,
small investors tend to panic and sell, forcing prices even lower. Once
an enormous short position is established, a smear campaign often follows,
characterized by negative articles from questionable sources and malicious
posting on message boards with no disclosure. The stock ends up trading
so poorly the company cannot raise equity capital, and many die a premature
death.
A high profile example of this kind
of practice occurred in the middle of December. Sirius Satellite Radio
(NASDAQ: SIRI) had been on a tear over the past several months. Clearly
the stock was richly valued and extended, and it was rumored short sellers
were getting killed. Miraculously a complete hatchet job article appeared
in Barron's, which sent the stock temporarily plummeting. While indeed,
there was a strong argument the stock was overvalued, the article was completely
one sided and gave no credence to the growth argument. A similar article
in the Wall Street Journal was much more balanced. If you think the Barron's
article was an accident, and short sellers didn't know about it in advance,
you are living in LaLa land.
Small companies have been hounding
regulators for years to take steps to eliminate these oppressive practices.
In February of last year the NASD one upped the SEC by implementing the
Affirmative Determination Rule, which required US brokerage firms to affirmatively
determine if an overseas brokerage firm selling shares through them can
actually deliver the shares. This made for some exciting moves in heavily
shorted stocks.
The SEC has finally implemented the
long awaited Regulation SHO. Regulation SHO went into effect on January
3rd. Beginning January 10th, each day a list of securities with excessive
open naked short positions will be publicly published.
This required list is referred to
as the Threshold Securities List. Under Regulation SHO, threshold
securities are defined by two criteria: 1) there are at least 10,000 shares
in aggregate failed deliveries for the security for five consecutive settlement
days and, 2) these fails to deliver constitute 0.5% or more of outstanding
shares.
If the failed deliveries for the
stocks on the Threshold List are not rectified within 13 trading
days, the market maker to whom the shares was sold will effect a "buy in"
in the open market.
Each exchange is required to maintain
a daily Threshold List. I am guessing the list will be found at
the web site of the exchange; i.e. www.nasdaq.com
and www.otcbb.com.
It will be interesting to start monitoring
the Threshold Lists for unusual movements to the upside.
I am not opposed to the practice
of short selling. I believe all investors should be able to bet on any
stock in either direction. I am opposed to sophisticated fund managers
with offshore accounts using loopholes to initiate trades you that you
and I cannot execute through our regular brokerage accounts. If they can
do, we should all be able to do it.
The Threshold List could become
a favorite resource for locating trading ideas on the long side. It might
become the sport of hedge fund managers. These new regulations are emerging
out of down side excesses from the the 2000 to 2003 time frame. The pendulum
is finally swinging back to a level playing field. These actions by the
regulators will help the OTC Bulletin Board become the incubator it is
intended to be.
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