The resumption of short selling, which had been suspended for the longest period in Korea’s stock market history, is now imminent. While retail investors worry that short selling will exert downward pressure on the market, experts predict that its overall impact will be limited. However, stocks that have seen sharp price increases, such as shipbuilding and defense stocks, and those with weak earnings like secondary battery stocks, are expected to be prime targets for short selling, leading to increased short-term volatility.

Lee Bok-hyun, Governor of the Financial Supervisory Service, delivers a congratulatory speech at a demonstration event for the establishment of a short-selling electronic system held at the Korea Exchange in Yeouido, Seoul, on March 19. Yonhap News

Short selling, which was fully banned on November 5, 2023, to curb naked short selling, will resume on March 31 after about 17 months. This marks the longest suspension among the four instances of short-selling bans in Korea, surpassing the durations of bans in 2008 (eight months), 2011 (three months), and 2020 (14 months). Short selling is an investment strategy where traders sell borrowed stocks, aiming to buy them back at a lower price to profit from a decline. Concerns are growing among investors as mid- and small-cap stocks, excluding the 350 large-cap stocks that make up the KOSPI 200 and KOSDAQ 150 indices, will resume short selling for the first time in five years since 2020.

Signs of short selling are already emerging in the market. According to the Korea Securities Depository, the balance of stock lending in the domestic market, which had remained below 50 trillion won since the second half of last year, surged to about 58.5 trillion won as of March 26. The stock lending balance, which refers to the amount of borrowed stocks that has not been repaid after borrowing stocks, is considered a preliminary stage of short selling.

Experts, however, believe the impact on the stock market will be short-lived as foreign funds that were disappointed by the short-selling ban may return. “In the past, when short selling resumed, volatility increased in the short term, but it did not affect the trend direction of the stock market, and gradual improvement in foreign supply and demand conditions is expected in the future,” said Lee Sung-hoon, a researcher at Kiwoom Securities.

According to data released by Daishin Securities, the KOSPI rose 14.7 percent, 10 percent, and 2.84 percent in the three months following the resumption of short selling after the bans in 2009, 2011, and 2021, respectively. Excluding 2021 (net selling of about 14 trillion won by foreigners), when individual investors led the market, foreigners net purchased about 12 trillion won in 2009 and 6 trillion won in 2011, driving the stock market's rise.

However, it seems inevitable that volatility will increase in certain stocks. Unlike in the past, the resumption of short selling is likely to lead to short selling of stocks with high or rapidly growing balance sheets, as “no borrowing” is blocked. Lee Kyung-min, a researcher at Daishin Securities, said, "Sectors with rising stock lending balances are more likely to see an inflow of short selling," adding, "There is a possibility of short-term supply and demand shocks, so managing volatility in these stocks will be crucial."

In particular, the commercial and capital goods sectors, which include defense, shipbuilding, and IT appliances and chemicals, which include secondary batteries, are seen as prime targets for short selling. In the case of commercial and capital goods and shipbuilding, the balance sheet has increased by more than 80 percent since the beginning of the year, while the IT appliances and chemical sectors have seen their stock lending ratio exceed 8 percent. Short sellers bet on stock price declines, and in this case, shipbuilding and defense stocks have soared excessively, while secondary battery stocks, despite their recent declines, face a worsening industry outlook.

In terms of stocks, companies with a stock lending balance ratio exceeding 10 percent, such as EcoProBM, POSCO Future M, and L&F, are considered likely targets for short selling. Additionally, stocks that have seen their lending balances surge by more than 200 percent since the beginning of the year, including Hanwha Aerospace, Doosan Robotics, and HD Hyundai Heavy Industries, are also being mentioned as potential short-selling targets.

Of course, being targeted by short sellers does not mean that the stock price will decline in the long term. When short selling resumed in 2021, stocks with high short-selling ratios, such as Hyundai Marine & Fire Insurance and Hanjin KAL, experienced sharp declines on the first day. However, within less than a week, they rebounded and generated excess returns.