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Uptick Rule: Meaningful or Meaningless?

Stocks in this article: GS MS C BAC

The Argument Against the Uptick Rule

Not everyone is in agreement that the absence of the uptick rule is to blame for the market's, and particularly the financial sector's, precipitous fall. Eric Newman, co-portfolio manager with TFS Capital, says that short sellers have been unfairly blamed for the real cause of the market's decline, namely that stocks went down because they were overvalued, there was too much leverage, and too many companies didn't bother preparing for anything but the best of times.

"It's funny that when the stock market starts falling, suddenly people are blaming the short sellers, but when the market is going up the short sellers are acceptable," said Newman. "But no one has any data. When you look at the data, the opposite is true. The price improvement is there because of short sellers, and they're making the market more liquid."

Newman says that between July 15 and Nov. 14, short shares outstanding fell by more than 5 billion on the NYSE and by more than 3.5 billion on the Nasdaq. But during that time, the S&P 500 fell 27.5%, and volatility (as measured by the Chicago Board Options Exchange Volatility Index, or VIX) more than doubled, increasing by 132%.

"How exactly did short sellers buying back 8.5 billion shares of stock cause the market to collapse and volatility to rise?" Newman asks rhetorically. "The answer is that they didn't."

In fact, some offer the argument that short sellers should be recognized for pushing share prices lower and thereby creating new opportunities for investors to buy companies at cheaper levels. Those who don't feel the uptick rule makes a difference say that strong companies aren't defined by their stock prices, but instead by their fundamentals.

"People like blaming somebody and they don't like to admit that maybe they made a bad investment," said Newman. "It's like everyone's at a cocktail party, talking about and blaming the short sellers. The rhetoric can get pretty heated. But these stocks are falling because they're losing billions of dollars. At the end of the day, it's business and earnings that drive stock prices."

Newman says the idea the stock market was protected for 70 years by the uptick rule is laughable. "It was during the uptick rule that we had the '87 crash and we had the Internet bubble burst. Now suddenly the uptick rule is down, and it must be the shorts that are driving the prices down," he said.

Michael Pento, chief economist with Delta Global Advisors, says that in the short term, a retail investor could be hurt if a large trader is driving a stock's price down. However, "if you're a long-term investor and the company is solvent and fundamentally stable, then you have absolutely nothing to worry about when it comes to the reinstatement of the uptick rule. In the long run, fundamentals always win out."

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