The Ripple Effects of VW's Stock Surge

Shares soared Oct. 27 and 28 as Porsche tightened its control over Volkswagen, forcing shorts to cover their positions and distorting the benchmark DAX index

The spectacular surge in Volkswagen's share price has burned speculators who had bet on a fall in the stock of Europe's largest carmaker in the financial crisis. Hedge funds lost up to €15 billion in just one day on Monday as VW stock prices skyrocketed, the Financial Times reported.

Those funds had entered into short-selling of VW shares—selling borrowed VW stock hoping the price would fall so they could repay with lower-priced shares and pocket the profit—and scrambled to buy VW stock when they saw the share price rise in the wake of sports car maker Porsche's announcement that it had increased its VW stake.

Such short-selling is always risky, but it rarely goes as wrong as it has with VW stock.

The number of free floating VW shares is shrinking because Porsche said on Sunday it had increased its direct stake in VW to 42.6 percent and that its combined stock and options totalled 74 percent. The state of Lower Saxony owns just over 20 percent, leaving a shrinking pool of VW shares for hedge funds to buy to "close their positions"—buy back borrowed shares—in a bid to cut their losses.

As a result, VW's share price closed up more than 146 percent at €520 on Monday. It doubled again on Tuesday, vaulting over the €1,000 mark. At the start of the year it had been priced at around €150. Market sources said short sellers had borrowed between 12 and 15 percent of VW stock.

The carmaker currently has a market value of around €153 billion—more than all its other European and American competitors put together.

Dax Index Distorted

The DAX index of blue-chip German stocks would be down due to recession fears if it weren't for the surge in VW shares which boosted the index by as much as 10 percent on Tuesday. Virtually all the other stocks were down. Investment funds that use the DAX as a performance benchmark have been forced to buy VW stock as well to keep up with the DAX, reinforcing the rise in the stock.

Stock dealers complained this week that the DAX was giving a distorted picture of the market, but stock market operator Deutsche Börse refused on Tuesday to take action. "One has to let the market take its course," a Deutsche Börse spokesman said. "There are no plans whatsoever to take VW out of the DAX."

Under Deutsche Börse's rules, there is no reason to take a stock out of the index as long as at least 5 percent of its shares are widely distributed and therefore in circulation. He added that there was no indication of any wrongdoing that would warrant taking VW out of the DAX.

Financial market watchdog BaFIN said it was analysing market developments but was unlikely to decide this week on whether to launch a formal investigation.

"It's no longer possible to describe what's happening on the German market," one trader on the Frankfurt Stock Exchange said. "One just has to say VW and that explains everything. This had made doing business in the German market seems a lot less respectable." Another dealer told a wire service: "If Deutsche Börse doesn't intervene, we're at risk of getting a systemic crisis."

Robert Halver, capital market expert at Baader Bank, said: "Such excesses aren't worthy of the DAX 30 index which is among the five to 10 most important stockmarket indices in the world."

Business daily Financial Times Deutschland wrote: "If a single stock can distort one of the world's most important indices to such an extent, the huge stock market chart over the Frankfurt trading floor isn't worth the electricity needed to run it."

"The lesson can only be that Deutsche Börse as the operator of the Frankfurt financial center must change its rules on weighting the individual Dax stocks—immediately."

Deutsche Börse's statute states that the weighting of stocks can only be changed every three months. VW's sharply increased stock currently has a weighting of 17 percent for the index, well above the permitted limit of 10 percent, but the weightings can't be changed until mid-December, the newspaper wrote.

"If the index isn't to become the laughing stock of all market participants the stock exchange must in exceptional circumstances be able to undertake an immediate correction. In these times of financial crisis especially, it's a worrying signal how easily the DAX can become a toy for gamblers."