TCS Daily

Spread the Wealth

By Kevin Hassett - December 16, 2002 12:00 AM

At a time when the press and politicians are fretting about investors losing confidence in stock markets, new information provided to the SEC offers reassuring evidence about the speed and fairness of transactions. But, by shedding new light on the relative performance of the major markets, the data also point out that improvement - at least for one of them - is both necessary and possible.

The Securities and Exchange Commission statistics show that, when it comes to individual investors buying and selling stocks, one of the two major markets - the NASDAQ - is strikingly superior to the other. A major reason is competition and technology. The NASDAQ Stock Market - which, unlike the New York Stock Exchange, is an electronic market - comes out on top in key measurements of trading execution.

Concerned that the little guy might be harmed by the actions of exchange insiders, the SEC's consumer-friendly chairman, Arthur Levitt Jr., wanted to require all market centers to make uniform statistics on execution quality available to retail investors, so they could judge for themselves how well an order to buy or sell was being carried out.
So Rule 11Ac1-5 (often called "Dash-5"), implemented in January 2001 by the commission, mandated monthly reporting of several key numbers - on how quickly markets execute stock trades and how close the "spread" (that is, the difference between offers to buy and sell) is on those trades.

So now we have the data we need to assess the performance of each market. For trades involving average investors, NASDAQ's results beat the NYSE's by a wide margin.

Consider companies that are among the components of the benchmark Standard & Poor's 500-Stock Index. These are roughly the 500 largest public corporations in America. As of Sept. 30, the NASDAQ listed 75 of them; the NYSE, 423 (S&P at the time had a couple of vacancies). According to analysis by Market Systems, Inc., a third-party vendor that compiles Dash-5 statistics, of reports to the SEC, it took 2.1 seconds, on average, to execute a trade for a NASDAQ-listed stock in the S&P 500 and 17.2 seconds to execute a trade on an NYSE stock in that index.

That's a huge disparity - but hardly a surprise when you consider that NASDAQ matches buyers and sellers through a sophisticated computer and telecommunications network while the NYSE uses "specialists" - humans trying to imitate competitive technology on the floor of an exchange on Wall Street. The NYSE's system may have more theatrical possibilities, but, for an investor placing an order to buy 100 shares of stock, it is a 20th (or 19th) century process in a 21st century economy and a price of a stock can change dozens of times in only a second.

The new data show that NASDAQ displays superior execution speed not just with corporate giants but also with the mid-caps of the S&P 400 index. NASDAQ lists 118 of these companies, with a mean market valuation of $1.6 billion; the NYSE lists 279. While the average S&P 500 company has daily trading volume of about 4 million shares, the typical S&P 400 company trades only 600,000 shares. Nevertheless, the average trade on a NASDAQ mid-cap stock is just 3.3 seconds; on a similar NYSE stock, 22.9 seconds.

The second key metric that affects the welfare of small investors was the spread between buy and sell orders. The bigger the spread, the higher the chance that the little guy is getting squeezed. Here again, NASDAQ appears to be the smoother marketplace. With S&P 500 companies, the average quoted spread for NASDAQ was 1.4 cents; NYSE, 2.9 cents. And the difference is much larger than the difference between the average share prices on both exchanges. For S&P 400 companies, the NASDAQ spread was 2.5 cents; the NYSE, 3.5 cents. The good news is that even with mid-caps, the gap between what the seller gets and what the buyer pays is only a few pennies - a far cry from the wide spreads that prevailed in the past, before the acceleration of technology and competition. But the difference is still noteworthy.

In terms of speed of execution and spreads these new data suggest that the benefits of competitive electronic markets can be fairly substantial. As exchange officials consider approaches to restore investor confidence in equity markets, meeting or exceeding the NASDAQ high-performance standards should be a worthy future objective.



TCS Daily Archives