At first glance, it's unclear who the winners are in the New York Stock Exchange and Archipelago (AX) - Get Report deal. The story is being greeted with a lot of excitement among analysts but none of the longer-term reasons are totally obvious.
Perhaps the greatest winners are the holders of NYSE seats, whose price has been continually going down on the heels of the dot-com bust and, more recently, the dual scandals of Grasso's pay and specialist frontrunning. NYSE seatholders must be thinking "Thank God!" They get a combination of cash and stock in this deal and get to exit gracefully if they so choose.
It's not clear Archipelago shareholders are winners, but I think there was a pyschological impetus for them to do this deal. After almost a decade of being the rebel in the exchange business, this deal now means they are fully "grown up."
Now, let's look at the losers.
The publicly traded
now has the NYSE breathing down its neck. Archipelago on a daily basis makes up 25% of the trading volume of Nasdaq issues. Pretty soon the NYSE will be able to argue that it makes a lot more sense to be listed on the NYSE and have access to all of AX's products and liquidity.
The exchange's stock is trading at $10.88 this morning, up 48 cents, because the reflex of traders is to trade where the action is, and this might not be a bad instinct. Also, while the Nasdaq might be a loser in the long term, there's a lot it can do in the short term to fight the good fight and traders are making a bet that this merger will spur the Nasdaq to action.
Van Der Moolen Holding
are clearly losers. The specialist firms have dug a hole, and because they are public, we are going to be able to watch them slowly sink in that hole and wait for the dirt to be shoveled on them.
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
, 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.
James Altucher is a managing partner at Formula Capital, an alternative asset management firm that runs several quantitative-based hedge funds as well as a fund of hedge funds. He is also the author of
Trade Like a Hedge Fund
Trade Like Warren Buffett. At the time of publication, neither Altucher nor his fund had a position in any of the securities mentioned in this column, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Altucher appreciates your feedback and invites you to send it to
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