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How Traders Killed Value Investing

  1. How Traders Killed Value Investing
    Want to know why GM stock is above zero? Look to hedge funds and short-term trading.

    Long before the June 1 negotiating deadline, it became quite clear that General Motor<file:///public/quotes/main.html?type=djn&symbol=gm>s Corp. was headed for bankruptcy. Its debtholders were going to get crushed. The shareholders were wiped out.

    Except that they weren't. As the deadline neared, shares of GM did a funny thing: They kept trading at more than $1 each. They didn't disappear.

    Last month, shares rose a few pennies during a given trading day and fell a few pennies the next. Taken as a whole, GM shares reflected nearly $1 billion in value that did not exist. Even today, with GM in bankruptcy, the automaker's shares are trading around $1.50.

    Market analysts seem baffled, but trading in GM reflects the sea change that's taken place in the markets during the last decade. Simply put, the market has slowly given itself to short-term traders. The traders control volume, and whoever controls the volume controls the price.

    The old notion that profitable companies with good growth prospects should have rising share prices -- and that failures like GM should be gone, or at least trading in the pennies -- is history.

    Traders gather at the kiosk where GM is traded on the floor of the New York Stock Exchange.
    Today, a hedge fund investing billions using a quantitative formula can stall a stock; a couple hedge funds aligned can turn a profitable company into a Dow laggard. Toss in a few short sellers and you have the great Wall Street collapse of September 2008.

    It wasn't always this way. Before the machines and the shorts took over Wall Street, stocks were evaluated by an underlying company's prospects. Buy-and-hold investing ruled the day. Investors such as Warren Buffett and Bill Miller were the models.

    Those fellows are a far cry from this generation's masters of the universe. Traders are in charge now. They rule the market. They dominate volume. That stock you bought because you thought the company was in good shape? It's a pawn in the hands of a computer model or some supertrader like Steven Cohen at SAC Capital Partners or Bridgewater Associates' Ray Dalio.

    To move a security, they don't need to own it. They can have a short position. They can put an order to sell 1 million shares in a dark pool, those anonymous marketplaces that operate outside the walls of the exchanges. They can own options or futures contracts. Buy enough GM puts and watch the price begin to fall under the pressure.

    Stocks As Targets
    For the long-term investor, whether you're investing for retirement or simply betting on a company's potential success, the payoff is suddenly in play -- every stock is a potential target of forces outside of the traditional movers.

    The buy-and-hold guys are still there, but lately they've been less successful than their hedge-fund counterparts.
    Mr. Buffett and Mr. Miller ride the wave of the overall market, hoping that their undervalued holdings will someday be valued by investors. The hedge fund guys create their own wave. Mr. Buffett is slow and deliberate with his investments, usually holding stakes for years. By comparison, Mr. Miller is a speed demon. He turns over 20% of his portfolio every year.

    Quants, hedge funds and today's new breed of trader can turn over their holdings in a day or even just a few hours.
    Slowpokes like Mr. Buffett and Mr. Miller don't bring Wall Street enough fees for the brokerages to care about them. For all the success markets and regulators have had in slashing trading costs, those reforms have inadvertently hurt small investors.

    Mr. Cohen and Mr. Dalio are exactly the kind of customer Wall Street cares about. You and the guy who runs your retirement portfolio couldn't provide enough fees to buy a dinner and drinks at Dylan Prime for the prime brokerage trading desk, much less a Bentley. The brokers just want to handle the action and they don't care what kind of order you place: long, short, puts or calls.

    As spreads on the exchange have shrunk, trading margins squeezed middlemen on every transaction. The best way to offset those losses has been to increase the number of transactions. Brokers have been happy to step up to heavy traders such as hedge funds and provide margin loans. Those loans not only increase volume, but carry more lucrative fees.

    The special attention paid to big traders doesn't only distort the market, it leaves fewer resources for investors with longer time horizons. During the last year, about 2,000 sell-side research analysts -- the guys paid to inform investors -- have exited the business, according to an earlier report in The Wall Street Journal.

    And why not, when machines make so many of the day's trades?
    Wagging The Dog
    Program trading, which mechanizes a variety of trading strategies, accounted for about 30% of volume on the New York Stock Exchange in May, compared to 10% a decade ago. It was just 4.6% for the same month in 1989. The NYSE cautions that its methodology for counting program trades has changed over the years, but you can see the trend.

    A 2007 study by the consulting firm Greenwich Associates found that the credit derivatives market -- the vast network of agreements and contracts that bet on debt -- now drives the pricing of the corporate bonds that underlie those derivatives, a development akin to the rabbit chasing the hound.

    Money managers have complained this trend is making corporate bond prices more volatile. The study concludes: "In many ways, hedge funds have become the market."

    A market dominated by nontraditional trading forces explains, in part, why GM shares have kept so much value. Arbitrage traders make a lot of contrarian moves. They buy to cover their short positions. They sell to take a profit. All they really need is for the price to move.

    There's no simple solution to the problems of the market. A few proposals today aim to improve things a bit, such as the elimination of naked shorting, reinstatement of the uptick rule and more transparency of traders' holdings. Some people, like Grant Thornton's David Weild are calling for separate markets for certain securities, such as newly issued stock.

    But separating investors from traders in the market would destroy it. The market needs both. Traders, after all, provide regular price discovery and the other side of the deal. They keep the market moving, but they've also replaced investors as the market's driving force. Don't bet on that changing anytime soon.

    Write to David Weidner at david.weidner@wsj.com<mailto:david.weidner@wsj.com>

  2. This guy must have shorted GM at $1.00 and now he's disgruntled that it never fell to zero like it "should" have.

  3. Ahhh, it should have gone to zero, the company is bankrupt. Equity holders will get zero value out of the re-org.
  4. It's not suprising that it didn't go to zero, the fed and treasury probably didn't sell their shares.

  5. I'm thinking that if you went back to the 1950's that the percentage of exchange traded stocks paying dividends would be higher than it is today (it's just a gut feeling, i did not check it out.)
    Stocks that pay significant dividends should maintain a connection to their fundamentals. But when there is no dividend, the connection of equities to the underlying is entirely "faith based" just as the value of a fiat currency is. So with the arrival of the "Go Go" years, hedge funds, derivatives and high volume automated trading it is not surprising that we see an increasing detachment of the equities markets from the fundamentals of the underlying companies. Now there is nothing but Price Action, Hype, and Faith for many stocks. If you are not going to trade then i think it is best to stick with dividend paying stocks. Gullible folks who believe the hype and try investing their 401K's in Go Go stocks (i.e., those with little if any connection to the underlying) will likely get burned.
  6. Interesting article

    Quenkish Zakos
  7. If a company pays out the dividends then the lower the price the more it has value to the investors. No trader of the company's common stock can kill the value ( dividends ) of a good business.
  8. that is true about dividend paying stocks.

    just go back and read almost any information about how stocks traded 80 years ago and the bigger names were all paying significantly (higher) dividends than today.

    however, the speculative names of yesteryear are less spec than today, but even some of those (like RCA) didn't pay a dividend yet reached dizzying heights.
  9. Lower dividends these days influenced by tax policy.
  10. btw, slight sidebar - if you ever look at older stocks through history, check out the floats (and number of shares issued) as compared to today.
  11. This article layers a ridiculous conclusion on top of misunderstood observations. What's it advocating, really? Bring back the "good old days" of high fees?

    The only area I see in which traders could harm value investing would be in using illegal insider information, which of course is already illegal (and prosecuted, thankfully). And I see no mention of that in this article. And besides, insider trading could be done just as easily by a "value investor" as by a "trader".

    Some people think that the Feds pumping billions into a defunct company can magically keep its equity afloat. May be right, may be wrong, I personally wouldn't touch it. And the point is...???

    Maybe in the very short term, but short-term traders can't control the long-term. Or have value investors suddenly become very short term? Then that's their own issue, and has nothing to do with traders.


    The reforms that hurt small investors have nothing to do with trading -- but it has a lot to do with banks and the connected overconsumption at all levels.

    Wrong again. The former middlemen were forced into early retirement. And if those heavy-trading hedge funds aren't profitable, they'll be gone, too. Harsh, but that's the reality of a more efficient environment -- unlike the one that the author apparently yearns for, where high fees buffered big firm profits ad infinitum.

    Reduce spreads benefit long-term investors. If they buy and hold, they pay a lot less to buy. Or should we be yearning for the days of 1/4 point spreads?

    The main job of a sell-side analyst was to generate investment banking revenue, not to provide objective analysis. Hear about many IPO's lately? Do the math...
  12. So I write calls on my long term portfolio and reinvest the premiums in addition to dividends. Buy and hold is fine you just need to milk the volatility by writing calls and compounding.

    I think the market is better the way it is today.
  13. Is it really the traders or the big banks that create the games? I mean some one has to be allowing all the excessive leverage. Someone is creating new derivatives.
  14. This is such a simpleton article, wrong on so many levels.
  15. Look at the M3 money supply. This also caused problems...
    since 1995 the entire market has been over valued... this has nothing ot do short-term trading.
  16. 1 + 1 = 2

    You do not need to quantify the above math statement that 1 + 1 has good value.

    So, what value investing really means, is that,

    1 + X = 2

    You know X = 1, but most other people think that X < 1.

    In short, value investing is about stealing the good stuff from the poor people who do not have the privileged information, and you choose not to tell the truth.

    By understanding this, then there is nothing wrong with stock evaluation in an open auction market being pushed around by whomever for the sake of making profit.

    After all, the dictionary definition of "invest" is to obtain profit from money that is put to use.

    Value or not does not matter.

  17. Why won't you write puts instead. Even better.
  18. I do as well. It all depends.
  19. Very few of the nation’s financial planning firms are structured this way.The debtholders were going to get crushed. The shareholders were wiped out. Except that they weren't. With advice from top independent financial advisors, empowered readers can make effective asset allocation decisions in the face of volatile markets.
  20. i asked here many times why GM was trading so high. Never got a straight answer.

    so if a genius can't figure it out, what shot do YOU have.

    ps, how be dem $1.00 June GM puts you loaded up on?
  21. Traders did not killed value investing.

    Investment banks that introduced illiquid OTC derivatives killed value investing.