Winners, Losers in NYSE Merger

For decades the specialists have been taking advantage of customers and I think the current investigations are only the tip of the iceberg. Once these indicted guys start cutting immunity deals it's going to be all over. Clearly, this merger was partly a response by the NYSE to the new trade-through rules that force them to open up their price discovery methods. Electronic trading is the only way to go.

Treading Lightly on a Limb

Ultimately there is more to this transaction than just the economics for these two companies and their shareholders. At the risk of going out on a limb, this merger justifies the trend that began in the 1970s of higher P/E ratios in the U.S. markets.

The average P/E ratio of stocks is not a function of interest rates or mean reversion, as most people say, but rather are perceptions of stability in the markets. As John Mauldin and Ed Easterling point out in their respective books, Bull's Eye Investing and Unexpected Returns, this stability is usually a function of inflation. In periods of steady inflation, P/E ratios are higher. In volatile periods, where inflation is moving quickly up and down (as in 2002), P/E ratios go significantly lower, and the markets decline.

I think another variable in the equation is investor perception of the market mechanics themselves. When there's scandal in the system (Grasso's pay, the specialists), the markets are unstable. Why invest in stocks when every dollar you put in has some pennies going into the specialists' pockets? This deal will enhance market stability.

Another factor is that with the NYSE-Archipelago merger, more products will be created. With the linking of electronically traded options, ETFs and listed issues, more products will end up being developed to allow people to further hedge and manage their risks in investing, freeing up their dollars to invest more in the markets, knowing their cushions are safer. This, in turn, will lead to higher P/E ratios, and higher markets.

All in all, this merger is an exciting transition for the NYSE. But the ultimate outcome won't be seen for years to come.

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