A Look Back at a Data-Driven 2019
As we near the end of a busy year, we take a moment to review some of the hot topics from 2019, and revisit some of the data we have discussed throughout the year.
We can’t cover everything, but you can search the full library here.
First, the basics
Throughout the year we published a selection of introductory pieces to help everyone become a market expert. Before we dive into detailed issues and market jargon, you can learn what we mean when we talk about:
- Market rules: The rules that govern trading and quoting, and what all the jargon and acronyms used in the market mean.
- Liquidity: From how much it’s changed, to where stocks trade and what stocks retail investors trade.
- Trading: From thinking about how fast you should trade, to how algos make most of the decisions about how and where to send orders into the market.
- Latency: Even after the market fully automated, it has continued to speed up as chip technology and capacity improves. It seems one thing you can’t change is the time it takes to trade.
The one thing missing from the data debate was data
The SEC data roundtable on data was more than a year ago. That set the scene for the first hot topic of 2019.
Sadly, one thing missing from the data debate was data. We think we’ve played our part in addressing that. Claims that exchange data revenues are rising “1,000%” or more just don’t add up – our exchange data revenues have roughly tracked the rate of inflation over the past nine years, even slower that the rate of increase in SEC fees.
It’s also important to put this debate in context, dispelling claims that exchange fees have a material effect on investor returns. The data just doesn’t support it.
Perhaps my favorite finding was that exchanges that charge separately for data, colocation and trading are actually cheaper than those that give away services for free. That’s not all that surprising, as free-riding results in an over-usage of free products which costs suppliers more—something that even IEX realized late in 2019 when they began charging connectivity fees. Instead, the data also showed that customers are selective when they choose what to buy, only paying for the services they need, with very few buying “premium everything.”
Then they shifted the debate to cross-subsidies and tiering—which was ironic given what we now know, from the Form ATS-N filings about ATS pricing, and with retail commissions falling to zero—platform discounts and incentives to trade are an industrywide standard practice.
In reality, the market is very good at engineering ways to “unbundle” trading. What’s harder is making sure those who benefit most actually pay for things that help them, like listings, tight spreads and instant liquidity.
Chart 1: User-pays exchanges are cheaper per trade than those with free services
Source: Nasdaq Economic Research
Issuers are an important part of the ecosystem
Sometimes lost in these debates is how important issuers are to the market. The SEC even created the EMSAC without any representation of listed, public companies! After all, without listed companies there are no stocks to trade, and less wealth building in our retirement funds. Issuers also keep us focused on market quality and capital formation in addition to liquidity and tradability.
The good news on capital formation is that 2019 was a strong year for IPOs, although that study also found the U.S. needs around 180 IPOs a year just to keep pace with M&A and de-listings.
Issuers and investors both appreciate low volatility and cheap liquidity in closing auctions. In our study of the Nasdaq close, we found that the average costs of market-close-liquidity was below 15bps, even for the largest imbalances. We also saw that our market makers price liquidity imbalances within a half-spread of the final close price in just 300 milliseconds—that’s efficient. It’s also consistent with a recent academic paper that found the Nasdaq close was less volatile and fairer than NYSE’s.
Chart 2: 2019 was a strong year for IPOs
Source: Nasdaq Economic Research
Stock splits, fractional shares, odd lots and inverted trading are all related
We’ve focused a lot on tradability, spreads and routing complexity this year. From studies that show how many odd lot quotes there are inside the NBBO on high priced stocks, including a SIP proposal to “sort of” add odd lots to the tape, to analysis of how traders use inverted venues when spreads are too large and queues get too long.
All of those trading problems could be fixed if the recent trend of less stock splits could be reversed.
Research shows stock splits benefit issuers too. We found companies that split their stock saw improved liquidity, less intraday volatility, and tighter spreads, and that relative valuations increased by around 5%, mostly between the announcement and effective date of the split.
However getting all companies to split to their “right price” is hard. That’s why we released our proposal for intelligent ticks earlier this week. Dynamic tick regimes aren’t new; Europe, Tokyo and Hong Kong have had them for a while. However, this proposal adds data from the tick pilot to make sure no ticker is harmed (no stock would have a tick that is wider than its current spread). That makes the economics of spread capture more consistent across all stocks, which should simplify routing and ideally reduce queue length, fragmentation, complexity, conflicts of interest and opportunity costs, while also tightening spreads and reducing trading costs.
Chart 3: Odd lots are more frequently the best quote in higher-priced stocks
Source: Nasdaq Economic Research
Rebates aren’t bad
Many of our studies have shown that market quality is highest in rebate markets. Spreads are tighter and quotes are more likely to be at the NBBO. That’s especially true for smaller stocks where the incentives to make markets is lower and stocks more frequently trade off-exchange.
We also showed that even though rebates are explicitly paid by takers, by helping to compress the spread they also benefit takers. Just another example of how market forces allocate trading economics more than we realize.
Ironically one of the strongest advocates against rebates and for free depth data is IEX, who we showed relies on rebate-market depth-data so that their complex hidden order can compete directly against those exchanges (using their data against them). Not surprisingly, we also found out their kind of market structure isn’t good for issuers, with lower intraday volumes, wider spreads and much more volatile closes. Making the whole ecosystem fair to others is hard.
Chart 4: Maker-taker markets have the best quotes and make the biggest contribution to the NBBO
Source: Nasdaq Economic Research
A year of big changes for retail and ETFs
There were some positive stories for investors too, especially for retail investors.
Not only did many retail brokers switch to commission-free trading, some also started to offer fractional share trading, a natural response to the lack of stock splits mentioned above.
The SEC’s division of Investment Management was also busy, streamlining the launch of new ETFs (the “ETF Rule”) as well as approving “non-transparent active” ETFs.
ETF inflows remained strong in 2019 with net inflows of around $280 billion. However, this year more than half of the inflows have gone to bond ETFs. Of the rest, more money was added to smart beta than index ETFs. That continues two multi-year trends showing ETFs being used to access the bond markets and for more “mutual fund-like” equity strategies.
Given that, it’s not surprising that data show ETF turnover is falling, indicating retail investors and others are using ETFs for longer-term exposures. All these trends promise to blur the distinction between traditional mutual funds and ETFs and mean that ETF trading affects stocks less than many think.
Chart 5: ETF creations and redemptions are a fraction of underlying stock trading
Source: Nasdaq Economic Research
A closing note on scheduling
As we head into the holidays, we’ll be taking a break. Happy holidays to all our readers; we will see you in 2020.
For those working through, don’t forget there are some modified trading days coming up:
And if you’re looking past that, see our trading calendar with holidays, expiry (witching) days and index rebalance days for 2020 here.
Other Topics
Markets Stocks Indexes US Markets
Phil Mackintosh
Nasdaq
Phil Mackintosh is Chief Economist and a Senior Vice President at Nasdaq. His team is responsible for a variety of projects and initiatives in the U.S. and Europe to improve market structure, encourage capital formation and enhance trading efficiency.
Read Phil's Bio