Unexpected Temporary Ban on Short Selling... Short Covering Effect Lasts at Most 2 Weeks?

A Different Pattern from Past Major Crises... "A Common Price Correction Phase"
Corporate Fundamentals, Not Short-Selling Ban, Drive Stock Price Direction
US Stock Market, Interest Rate Trends Also Influence Stock Prices

"This temporary ban on short selling is a different measure compared to past major crises. Looking at the decline from the six-month peak, it recorded -14.6% at the end of last October. When observing the overall trend since 2000, it is not at the level of a major crisis but merely a common price correction."

The majority of analysts in the securities industry evaluate that this temporary ban on short selling is different in nature from previous ones. Investors' attention is repeatedly drawn to 'short covering' (repurchasing stocks to close short positions) themes, but they advise that it should be approached from a short-term perspective. Since relying solely on the demand from short covering, which involves buying stocks to repay borrowed shares, has limitations in driving price increases, they recommend focusing on fundamentals, the U.S. stock market, and interest rate trends to devise investment strategies.

On the 8th, Kim Jung-yoon, a researcher at Daishin Securities, stated, "Looking at the overall trend since 2000, the current index is not at the level of a major crisis but can be seen as a common price correction," adding, "It is unusual for a full ban on short selling to be implemented at a time that is not a major global crisis."

There have been three instances in the past when financial authorities implemented a full ban on short selling: during the global financial crisis (ban period from October 1, 2008, to May 31, 2009), the European sovereign debt crisis (ban period from August 10, 2011, to November 9, 2011), and COVID-19 (ban period from March 16, 2020, to May 2, 2021). All shared the commonality of a sharp stock market decline accompanied by amplified domestic and international economic uncertainties. Researcher Kim Jung-yoon noted, "The market's attention is turning to short selling investment strategies in line with the financial authorities' stance to quell market anxiety related to illegal short selling and to improve the system," but advised, "Since this short selling ban is different in nature from the past, it is necessary to approach it differently."

In the past, short selling bans served as a kind of safety net during crises. However, during global crises, the main factors driving stock market rises were monetary and fiscal policies implemented to stimulate the economy and financial markets. As issues such as U.S. Treasury yields and uncertainties related to monetary policy ease, the global stock market rebound continues. Unexpectedly, this full ban on short selling has stirred up a short covering theme. Researcher Kim Jung-yoon emphasized, "Sometimes, autonomous rebounds driven by simple supply and demand, which cannot be explained by fundamentals, may appear larger than expected, but stock prices ultimately follow fundamentals."

Kim Jong-young, a researcher at IBK Investment & Securities, also analyzed, "The stock price rise after the short selling ban in March 2020 was a case of a rebound following a sharp market drop caused by extreme fear, aided by successive fiscal and monetary policies in advanced countries," adding, "It can be seen that the market recovered as the liquidity environment eased rather than because of the short selling ban." He further explained, "After the three previous short selling bans, the KOSPI moved in tandem with the U.S. Standard & Poor's (S&P) 500 index," and "Therefore, this time as well, the medium- to long-term trend of the KOSPI will be influenced by the direction of the U.S. stock market and interest rates."

There is also an analysis that the influence of short covering due to the short selling ban will weaken after peaking at two weeks. Laborngil, a researcher at Shinhan Investment Corp., pointed out, "The short selling ban involves a relative overvaluation of spot stocks compared to futures from a medium- to long-term perspective," adding, "Institutions and foreigners tend to respond with arbitrage trading during this period, and the dependence on individual investors' demand is likely to increase further." He continued, "Considering the relative expected returns of the stock market compared to interest rates and the liquidity environment, the strength of individual demand inflows may be weaker than in the past," and predicted, "The influence of short covering due to the short selling ban will peak at two weeks and then weaken."

In fact, the stock market, which surged unprecedentedly on the day the short selling ban was implemented (the 6th), fell more than 2% the very next day on the 7th, leading to reactions that the effect of the short selling ban was short-lived. Most of the secondary battery-related stocks, which were the main drivers pushing the stock index to its largest increase ever, fell sharply, leading the correction mood. The KOSPI closed at the 2440 level, down more than 2%. The KOSDAQ, which triggered a sell-side car during the session, also closed down nearly 2%.

Kim Seok-hwan, a researcher at Mirae Asset Securities, noted, "The demand effect from the government's short selling ban is short-term, so it is necessary to consider the company's fundamentals," adding, "If foreign or institutional selling of spot stocks continues, stock prices are likely to return to their original levels." Researcher Laborngil emphasized, "The variable that determines the stock market impact of the short selling ban is fundamentals," and said, "When the short selling ban coincides with fundamental improvements, it supported the downside of the stock market in the short term and acted as a factor leading to an index rally amid weakening selling pressure in the long term."