Oct 28: Volkswagen short squeeze
VW stock shot up as investors who had bet on a fall in its share price scrambled to cover losses on their short positions, says John Authers
Hello, and welcome to the Short View. I'm John Authers.
We've had an extraordinary day on world markets today, and people have poured money back out of the yen, and they seem to be putting it into American stocks because it looks as though the S&P and the Dow are going to be up more than 10% for the day. For now, I'd like to talk about another extraordinary event that happened in Europe. And that was what appears to have been, arguably, the biggest short squeeze ever, in the shares of Volkswagen.
What we're showing you here is the share price of Volkswagen compared to the German DAX index, of which it's a member, since the beginning of the decade. Volkswagen is obviously a very large, and in many ways, rather boring car manufacturer. You can see that by the end of last year, it had very strongly outperformed the rest of the DAX, and it therefore seemed to be a very good bet to short-- i.e., borrow the stock and sell it so that you could buy it back for a profit once the share price goes down.
Unfortunately, it turns out that what has been supporting the share price may well have been that Porsche, its rival German car maker, has been building a stake. It was announced this week that stake now appears to have become a controlling one. And as a result, people desperately ran to cover their short, to buy Volkswagen to limit their losses. Because there were so few shares left in free circulation however, it was very difficult to do so, so the price just went up and up and up. Briefly today, Volkswagen was the biggest company in the world by market cap. Anybody who shorted Volkswagen at the end of last year has lost about 500% on that position.
Now, few people have done that, but what I'd like to show you now is something that many people may well have done. The market neutral strategy is very popular. It's where you take two similar companies, bet that one will do better than the other, go long the better one and short the one that you think will be the relative loser. That way you're not exposed to moves in the overall market.
So this is what would have happened if you'd gone long Daimler, another big German car maker, short Volkswagen at the beginning of this year. It's an apparently conservative strategy, but it would have lost you 95%. Now, many people are asking themselves who exactly has lost money here, because many people must have lost a lot, and what will they be forced to sell as a result?
Now, short squeezes can have perverse effects in markets which you wouldn't expect. We can illustrate that for you with this graph, which covers what was perhaps the most important market move of the year. It shows you how the price of oil has done, relative to the price of shares in US banks.
It was very popular to go long oil and fund that by shorting US banks, until July, when the SEC announced a ban on shorting financials. That left lots of people to cover their shorts in financials, and to do that, they needed to sell oil. As a result, as you can see, you saw a remarkable snap in that trade, and that was, it turns out, was the beginning of the great bust in the oil market. What people are worried about now, even after the big rally the market had had today, is that we could see some similar kind of perverse fallout from the short squeeze in Volkswagen.