Thursday, 25 August 2011

What’s wrong with the PSE?

Business Mirror

If there was a magic wand that could be waved at the Philippine Stock Exchange (PSE), the two basic changes that I would like to see are longer trading hours and a much higher float of publicly owned shares of listed companies.

In a couple of months, the trading hours will be extended by one-and-half hours. That is a baby step to proper trading hours but it is a start. Next year, the exchange plans to extend trading even longer with a lunch break in between sessions. The lunch break is completely silly and makes the PSE look like it is still in the age of writing prices on a chalkboard. I guarantee you it is going to be very difficult to get stockbrokers to come back after lunch. PSE brokers and investors have never worked a full day so it will be a huge cultural shock.

They will get used to it once they have missed a few profit opportunities from being absent.

The PSE and Securities Exchange Commission are eventually going to have to get serious about the public ownership and free-float rules for public companies. Far too much of the percentage of public ownership of far too many companies is minimal. Local corporations often see public ownership as a necessary evil to raising money in the stock market. For many, the only reason to be listed on the PSE is to be able to provide a market value for their shares in order to be able to provide a reasonably accurate corporate value when they borrow money.

Unfortunately, we will never have a stock exchange that meets global 21st century standards until listed companies are required to have and monitored to insure at least 25 percent of their shares in the hands of the public. This would increase volume of trading and the amount of public investment. It could be accomplished by both the issuance of new shares and stock dividends. Share prices would be reduced as the number of shares increases, making it easier for smaller investors to get in the market.

Those are my only two complaints.

So what’s right with the PSE?

If you want to play, you have to pay

Crashing markets, stock, real estate, or whatever, are caused by asset-price bubbles. Asset-price bubbles are caused by buyers buying with borrowed money. Very few asset-price bubbles and subsequent price devastation can be attributed to cash purchases.

Most investors on the PSE have never traded with borrowed money, buying stocks on margin. Local stockbrokers do offer margin-trading facilities but only for a very favored few issues that have relatively stable price movements.

In the West, no one buys with cash; it is all bought with borrowed money. As a result, a 20-percent drop in the stock price means a 40-percent drop in the investor’s portfolio. Margin trading creates increased volatile price movements as “ordinary” selling can become “extra-ordinary” selling to cover margin calls as the stock price goes lower.

Humans still push the buttons

The 21st century saw the advent of computer trading, using the ‘”black box,” or “robo trading.” Tell your computer to buy if the price drops 3 percent and to take a profit if it goes 10 percent higher. Great. Like an autopilot, set it and forget it. As high as 80 percent of all trades in 2008 were computer generated.

Problem is too many of the computers are programmed to think the same. If all the computers buy at 10 and sell at 12, you get the crazy markets as we have now. Add to the equation what is called HFT, or “high-frequency trading,” which accounts for 70 percent of all entered orders, and prices swings become even more ridiculous.

HFT computers enter thousands of orders a day, trading for a few fluctuations either up or down. Stocks in the US have dropped 50 percent and more in a few seconds and then gone up by as much, also in a few seconds because all the HFT computers are hit with thousands of the same buy/sell orders at the same time.

At the PSE, we do things the old-fashioned and sensible way; a human makes the order decision and even then you get wild, very short-term price action but not as bad as with the “black box.”

The PSE is far from reaching its potential. But good things are happening. The move to do all that is possible to develop online trading is a very important positive step. This will allow investors, particularly those outside of Metro Manila, to participate in the stock market.

On a personal note, you can follow “mangunonmarkets” on Twitter.

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