What Happened to Fundamental Investing?
April 1, 2014
Open any newspaper or turn on any business channel in the past 72 hours and the headlines scream stock market manipulation. In his new book “Flash Boys” promoted on CBS’s 60 Minutes, Michael Lewis ignited a firestorm over the role of high-frequency trading (“HFT”) that has carried over into every facet of the media and with the regulators. Today’s WSJ lead headline announces the FBI is investigating HFT traders, while NY Attorney General Schneiderman launched an investigation last week into the same topic. Whether you believe the rhetoric regarding HFT or not, the unintended consequences have investors once again questioning the integrity and stability of the financial marketplace and asking just how level is the playing field.
When did this conflict in the marketplace begin? Regulation NMS (“Reg NMS”) – launched in 2007 – was intended to modernize the U.S. equity markets, but to many industry participants instead created a fragmented marketplace that drove investors to crossing networks and dark pools when looking for execution liquidity. Whether it was Reg NMS or the beginning of decimalization (and then sub decimalization), payment for order flow, the onset of internalization engines, or when the exchanges went public (for profit), it’s hard to point to only one event that created the current state of noise in the equity markets.
Where does all of this leave the individual investor? Maybe Jimmy Page said it best with “Dazed and Confused.” Today’s fundamental investors face a continuing dilemma on how to mitigate the noise of the stock market and its effect on underlying stock prices. Over time, evidence suggests there is a real disconnect between the price of the market influenced by external noise and rhetoric, and the underlying fundamentals that drive corporate intrinsic value. We at Reality Shares believe corporate fundamentals should be the principal driver of stock price. We are working hard to provide the tools, indexes and analytics for investors to isolate fundamentals from the noise, and to help market participants make informed decisions based on tangible corporate results.
Decimalization = A system where security prices are quoted using a decimal format rather than fractions. Payment for Order Flow = When exchanges pay brokers for routing an order to them — perhaps a penny or more — as a way to attract more orders from brokers. Internalization Engine = An environment where broker-dealers match orders internally on their own trading desks before sending them to either dark pools or exchanges.
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