Market harder for specialists

Discussion in 'Order Execution' started by Tea, Apr 12, 2003.

  1. Tea


    Here is a partial quote from today's Barrons article....

    THE PACE AND CHARACTER of stock trading so far this year has not been kind to the market's middlemen.

    Not only have share trading volumes trailed off, the higher turnover of low-priced stocks has hurt dollar volume even more. And given the market's key drivers -- hedge funds gunning stock index futures and flipping exchange-traded funds rather than playing individual corporate situations -- stock-specific activity ebbed dramatically during the war's prelude and the conflict itself.

    Computer-propelled program trading now routinely accounts for 35% to 40% of New York Stock Exchange volume, as retail investing has dried up and institutions seek more cost-efficient techniques and pursue quantitative trading strategies. Pricing stocks in decimals has helped bring the typical size of a trade down dramatically, for various technical reasons. According to Morgan Stanley, the average trade size on the NYSE and Nasdaq has fallen to below 600 shares from about 1,400 shares in 1997.

    All this has made it tougher for Wall Street dealers to make a buck, whether on upstairs trading desks or on the exchange floor. The big brokerage houses have been trimming headcount in their equity-trading areas. The tougher environment has also affected one of the longest-tenured indicators of Wall Street fortunes, the price of a NYSE membership seat.

    As the nearby chart shows, the last sale of a seat occurred in March at a price of $1.5 million. That's down from a peak of $2.65 million in late 1999 and $2 million as recently as November 2002. This has proven something of a lagging indicator. When this graphic last ran in this column around Thanksgiving, the seat price had held up unusually well given the tumble in share prices of the prior years. The firmness in the value of NYSE membership indicated an excess of hope for a quick market rebound, as noted here at the time.

    The question now is whether the latest dip in trading activity is the beginning of a long-term cooling of fevered trading levels, similar to drastic slowdowns that have accompanied bear markets through history.

    Morgan Stanley analyst Henry McVey thinks the annual NYSE turnover ratio (dollar volume divided by average market value of all stocks) will moderate to 90%-95% from last year's 102%, but won't recede toward the 68% level of 1995. Funds focusing on certain types of arbitrage and other high-turnover strategies -- a much bigger part of the market than in years past -- now account for 30%-45% of Big Board volume, McVey estimates.

    It remains to be seen whether this sort of activity will keep the trade tickets flying, should the bear market drag on much longer.

    Few companies have a greater stake in whether trading stays brisk than LaBranche, the biggest publicly traded NYSE specialist firm. The company makes a market on the floor for some 650 stocks, including one-fifth of the S&P 500 membership, matching buyers with sellers and stepping in to take the other side of the trade when necessary. The latter activity, principal trading, is where LaBranche makes most of its money.

    But the sluggish pace and limited intra-day volatility made it tough for the firm in the first quarter, leaving scant opportunity to get out of principal positions profitably. It has twice cut earnings forecasts.

    This caused some alarm on the Street that a big trading loss or a long-term decline in margins was to blame. The company has adamantly refuted this, says Putnam Lovell analyst Richard Repetto, who believes it was an extraordinary cyclical problem, not a structural issue. The company is likely to report depressed earnings of 7 cents to 8 cents a share Tuesday, but Repetto thinks normalized quarterly earnings are 25 cents to 35 cents, indicating about $1.20 a share in annual earnings power.

    At about 18 (down 32% on the year), LaBranche trades at 15 times the more typical earnings run rate, not dauntingly expensive but not all that cheap given the newly evident earnings volatility.

    There are worse ways to play a market rebound, of course, given that the company claims never to have been unprofitable for a quarter in its nearly 80-year history. And just last week, intra-day volatility ticked higher and stocks began moving on corporate news and analyst action again -- all of it good for LaBranche.

    The stock is also effectively a call option on the abiding efforts of professional investors to try and trade their way out of a bear market.
  2. when the markets become tougher, specialists just become more crooked- ie holding cancels, ignoring NX, not providing liquidity, itemizing orders, etc. I really don't feel bad for these guys, they still have the biggest advantage on the street- knowing 100% of the order flow available in their particular stocks. some of these guys should be investigated b/c they sure as hell don't provide a fair and equitable market. on top of all this, the SEC raises our fees now but does nothing to provide value added to us for these fee increases or to crack down on crooked specialist practices. what a racket they have going.......