[At a Crossroads: Short Selling] Short-Term Stock Price Decline Expected, but Foreign Investor Inflow Also Possible

Diverging Opinions on Stock Market Impact

[Asia Economy Reporter Minji Lee] Will short selling drive stock prices up or down? Opinions on this are divided. While short selling tends to cause short-term stock price declines, it also attracts foreign investors to the domestic stock market, thereby playing a role in supporting stock prices.

According to the financial investment industry on the 21st, the general view is that there is a possibility of index decline in the short term after the resumption of short selling. It is expected to mainly affect healthcare and KOSDAQ stocks, which had high loan balances. In 2011, short selling was banned in the domestic stock market for about 92 days (3 months) due to the European fiscal crisis and the downgrade of the US credit rating. After the ban was lifted, the KOSPI plunged nearly 4.9% on the same day, as trading volume surged to levels similar to those just before the ban. Recently, ahead of the lifting of the short selling ban, the loan balances, which represent funds waiting for short selling, have increased again mainly in biotech companies that surged in the first half of the year, raising the possibility of a decline. Min-gyu Kim, a researcher at KB Securities, explained, "From a short-term perspective, historically, sectors with high loan balances just before the short selling bans in 2008 and 2011 underperformed sectors with lower balances. As pent-up short selling demand increases, it could shock the stock index, mainly in healthcare, industrials, and IT sectors."

On the other hand, some believe that if short selling resumes, backwardation will be resolved, leading to an influx of buying in the spot (stock) market. Backwardation refers to a situation where futures prices are lower than spot prices. Due to the short selling ban, investors who built short positions through futures sales increased futures selling demand, causing futures to be undervalued. If short selling resumes, this futures selling demand will ease, resulting in an influx of spot buying.

Typically, futures prices form a 'contango' market (where futures prices are higher than spot prices) reflecting financial costs and risk premiums. However, due to the short selling ban, among 136 individual stocks, 62.2% were in backwardation, a significant increase from 39.5% before the ban. Consequently, foreigners have been selling spot stocks and buying futures, putting supply-demand pressure on the stock market. Dong-wan Kim, a researcher at Eugene Investment & Securities, explained, "Foreign investors have actively bought undervalued futures and sold spot stocks, but if the trading ban is lifted, the undervaluation of futures is expected to be resolved, and foreigners are expected to switch to net buying of spot stocks."

This content was produced with the assistance of AI translation services.