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The Real Stock Market Villain

Corporate executives who huckster their stocks rather than run their businesses are a bigger concern than high-frequency trading.

John Rekenthaler, 01/24/2017

Falsely Accused 
Michael Lewis' 2014 treatise on high-frequency trading, Flash Boys, generated enormous attention. The most comments this column has ever attracted was when it reviewed the book.

Unfortunately, the story lacked a true villain. Yes, Lewis had some success at painting high-frequency traders (HFTs) as all things anti-American. However, the charge has not stuck. HFTs figured out how to get an edge on their trading competitors by purchasing data from stock exchanges, establishing rapid communications lines, and collecting many, many pennies. You might not like them, just as you might not like McDonald's displacing mom-and-pop diners, but it's hard to argue that HFTs are anything but a conventional business success.

Now, as my colleague Eric Jacobson points out, this version of democracy isn't exactly democracy for all. It's democracy for those who are wealthy enough to play the game. If you don't have a few dozen million dollars with which to pay the stock exchanges and purchase the necessary technology, you can't play the game. Once again I say: Welcome to America!

Another problem with casting HFTs as the baddies is that they don't hurt Main Street, at least not in any meaningful way. At circa $2 billion, annual HFT revenues amount to about 0.01% of stock market trading volume. Using a very rough back-of-the-envelope calculation, this means that a retail stock investor who owns $250,000 worth of stock and who turns over 20% of her portfolio each year, would spend $5 a year on HFTs. It might not even be that much. Many credible sources, including Vanguard CEO Bill McNabb, have argued that HFTs improve retail investors' returns by increasing stock-market liquidity, which lowers trading spreads.

Guilty Parties
Here is a better idea, for Mr. Lewis' next expose: Companies that spend their time attempting to boost their stock prices. Consider the opening paragraph of "Analysts Say 'Buy' to Win Special Access," published in Friday's The Wall Street Journal:

Analysts who want top executives at Coach to attend private events with their investor clients have to show they are "brand ambassadors," as the luxury handbag retailer dubs it. You can't be a brand ambassador if you have a sell rating on Coach's stock.

Well now, isn't that lovely. Corporate executives dangle the carrot of swanky parties in front of stock analysts, while simultaneously brandishing the stick of banishment, should the analysts resist. If analysts accept the offer that they dare not refuse and recommend the company's stock, they then can use the party invitation to flatter their clients by escorting them to exclusive events. The clients, who are mostly professional investors who bear a fiduciary duty to people who are not invited to such parties, and who never will be invited to such parties, accept the invitation on behalf of those people who were not and will not be invited.

If you like how that sounds, you'll love the International Olympic Committee.

is vice president of research for Morningstar.

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