Despite the eight-year bull market in equities, more and more market analysts are referring to the trade in U.S. equities as weak, depressed and even worse. A major national newspaper last spring asked: “If No One’s Trading Stocks, Is it Really a Rally?” The article noted that “few investors have come to the party,” citing recent average daily volume of 6.9 billion shares.
The real story is that the average daily share volume for the 12-month period ending April 30 is down about 9% from the same period four years ago, averaging about 6.7 billion shares per day (excluding auctions and odd lots). However, average notional volume — the actual dollar amount that is traded each day — rose 15% during that same period to more than $283 billion. Simply put: the share liquidity in our market is down while the notional turnover is up.
Even more startling, when comparing January 2016 to January 2010, share volume increased only 1.92% while notional volume rose 42%. What is causing this phenomenon and how is it impacting our market liquidity and, ultimately, investors?
One contributing factor is the refusal of corporate issuers to split their stocks since the end of the financial crisis. In an ill-conceived effort to attract “long-term investors” and detract “speculators” from trading their stocks, a number of popular U.S. companies have kept their nominal stock prices above $200, $500 or even $1,000 per share. While intended to attract buy-and-hold investors, these higher nominal stock prices can negatively impact liquidity, trading costs and investor participation, affecting returns and the value of equity holdings for investors both large and small.
Splitting a stock does not directly change a company’s value or the overall value of an investor’s holdings. Yet, historically, psychology has played a role in determining optimal prices at which to buy stocks, especially for retail. An average individual investor may avoid a $500 stock as being too richly priced but change his or her view when that security is split 10-for-1 and then trades at $50. Currently, there are 44 U.S. corporate securities trading above $200, including high-flying titans such as Amazon ($717) and Google ($710).
Further, the current average stock price for the S&P 500 is $83.87, a stark contrast to the average of $30 to $50 from 1980 and 2011. In addition, there are some structural issues resulting from ultra-high-priced stocks that have been largely ignored. For one, these securities increase the cost of execution for all investors by widening bid-offer spreads. The bid/ask spreads in these expensive stocks can be as much as five times greater on a percent basis than their lower-priced counterparts. This leads to much higher costs for both large and small investors. These costs, which explode for large investors, lead to lower participation from retail investors, market makers and other market participants, all of whom must commit more capital simply to trade a single round lot of stock, thus, contributing to a wider spread and less liquidity (see “Breakout” page 78, for a breakdown of bid/ask spreads for the largest stocks).
While per share commissions for institutional investors will rise if these higher-priced stocks split, the increase in explicit costs will be far outweighed by the savings from the lower implicit costs of tighter spreads and lower market impact. A recent study from Instinet explored some of the challenges of trading very high-priced stocks, highlighting declines in both the depth and duration of the quote in addition to the wider spreads.
What about the “buy and hold” argument? While it’s nice for a company to say it wants to attract long-term buy and hold investors, failing to split a high-priced stock encourages small investors to avoid a stock altogether or causes them to pay a substantial penalty when they trade such a security (and, yes, small investors sometimes have to sell stocks to pay for college or buy a new car). One could argue that a company’s refusal to split its stock is a refusal to embrace middle class retail investors with less investable wealth.
If just half of the companies with stock prices above $200 were to split, investors would immediately experience a savings from the smaller spreads and higher liquidity. Also, a wider swath of investors could access these stocks. The Intercontinental Exchange Inc. (ICE), the owner of the NYSE, which trades close to $256 per share, could offer a stock split to send a signal to corporate America.
When debating plots with the goal of making stocks trade better, we should also focus on the instantaneous benefits of stock splits. While this is self-serving to a degree, given our per-share revenue model, the evidence is clear that many investors would save money and more investors could participate.