The Market's Molotov Cocktail
It's hard to ignore what's going on with the electronic global exchanges right now. I know I should be discussing actionable small-cap investments. But the reality is that small-caps, like all stocks, are traded on electronic exchanges. And I want to make sure you are aware of what's going on, so you can act accordingly.
Country crushing debt (a.k.a developed nations) combined with piss poor trading transparency is akin to throwing a Molotov cocktail into the stock market – effectively disrupting hope for a sustained stock market recovery.
I've been thinking about this 'circuit breaker' debacle that allegedly contributed to the nearly 1000 point plunge in the Dow last week. And I've got to tell you, it's unsettling. The executives of electronic exchanges – the Nasdaq
Of course, as small cap investors who occasionally trade over-the-counter stocks, we're somewhat used to big percentage point changes in the stocks we buy. In some cases, we try to use that to our advantage. A stock that trades less than 20,000 shares in a day and has a market cap under $50 million is not exactly a liquid investment. That's fine – because that's the bull we jump on. And that's what we expect from small and micro-caps going in.
***But I don't expect that with Procter and Gamble (NYSE: PG). This stock has a beta of .54, meaning it is half as volatile as the broader market. So when, within a 30 minute window, a 100 share order crosses at $56.32 on the NYSE exchange, and different 100 share lots pass through at the Nasdaq
Now I could go into the definitions of transparency that institutions like the Financial Accounting Standards Board (FASB) suggest to help determine fair value. These differentiate 'quoted prices', from 'observable values' from 'unobservable values'. These accounting terms are used to determine fair value for financial instruments with varying levels of liquidity and transparency.
But I'd like you to finish reading this letter so I'll sum it up in one sentence.
Fair value is what you can get for something you want to sell – period. The more buying and selling that occurs, the more accurate the price. This concept is what spurred the move toward electronic trading. And I think the concept is sound.
***It's also why spreads on mega caps like Procter and Gamble are usually so tight – they are very liquid, and very transparent. Accordingly they are very accurate, hence the small beta of the stock. Or at least they are supposed to be. The order execution of this system needs to be re-tooled.
When massive spreads arise, like those that did last week, fair value is much harder to determine. There are huge winners, and big losers. There are massive arbitrage opportunities. Buy on one exchange for $39.37 and sell on another at $56.32? Sure, I'd take that deal.
Now I don't know if it would actually be possible to put that trade on, but you get my point.
The same exact item, in this case a share of Procter and Gamble stock, absolutely cannot trade on different exchanges at different prices if there is to be any confidence in the global stock market – period.
That's like moving all stocks to the grey market – where liquidity, transparency, and order routing are anybody's guess.
I'm ok occasionally buying and selling micro-cap stocks that trade in huge ranges within a very short time frame. I expect that and accept the risks going in.
But I'm not ok when this happens with stocks that investors buy precisely because they are not volatile. These are the stocks that are widely held by conservative mutual funds, and that many people hold in their retirement accounts. This is not the place to gamble, speculate, and have poor mechanisms for price discovery.
***Ok, that's my rant for the week. It's good to get it out, and I hope the exchange operators are paying attention. They're going to Capitol Hill this afternoon to testify at
What are your thoughts? Drop me a message, my address is: editorial@smallcapinvestor.com
