Is NYSE Being Kept Too Cool Under Its Collar?
Everybody agrees that too much volatility in the stock market is a bad thing. But can too little volatility also be a bad thing--maybe even a worse thing--in the long run?
Consider the case of the New York Stock Exchange “collar” formally put in place in July, 1990, and now rarely discussed on Wall Street.
With the continuing public uproar in the late 1980s over wide market swings, the NYSE decided to limit so-called program trading--computerized, high-speed trading of baskets of stocks by major investors. The idea was to slow down those trades by cutting off program traders’ access to key NYSE computers whenever the Dow industrial average moved 50 points up or down in a day.
If the public saw a less volatile market, the NYSE and the Securities and Exchange Commission reasoned, confidence in stocks would be restored. After all, even by 1990 memories of the Dow’s 508-point, one-day crash on Oct. 19, 1987, remained fairly fresh in the public psyche.
Now, after more than three years of a collared market, proponents of that action have declared victory. The NYSE notes with pride that the collar has been triggered fewer and fewer times each year since 1990. What that means, of course, is that the Dow is rarely rising or falling 50 points in a day anymore. And broader market indexes, such as the Standard & Poor’s 500, have for the past two years moved in an extraordinarily narrow range as well.
Volatility, it seems, has been conquered.
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But hold the fort. When the 50-point collar was imposed in July, 1990, the Dow was at 2,999. Today it’s at 3,895. Because the collar’s parameters haven’t changed while the market has risen substantially, the effect is to restrict daily market volatility to a narrower range as the bull advances.
At 2,999 on the Dow, a 50-point change was a 1.7% price move in the underlying stocks. At 3,895, a 50-point change is a 1.3% price move. At Dow 5,000, the collar will be imposed if the Dow stocks collectively rise 1%--or 30 cents on a $30 stock. This begs a simple question: If the collar isn’t widened as the market goes up, is this limitation on big investors’ activity interfering with the market’s ability to price stocks accurately?
The NYSE says no. The issue of adjusting the collar point change “came up recently in an informal meeting we had with the SEC,” said Ed Kwalwasser, the NYSE’s regulatory chief. The outcome of that meeting, he said, was that “there’s no reason to change” the collar. Though its percentage impact may be less, 50 points on the Dow “is still a substantial move” in the eyes of small investors, Kwalwasser argues. In fact, he said, “it would be even if the Dow was at 10,000.”
Indeed, Michael Metz, veteran market analyst at Oppenheimer & Co. and no fan of program traders, echoes many Wall Streeters who are quite happy with the NYSE collar and its effects. “I personally think there’s no reason to widen it,” he said. “That would just accommodate the players in these derivative securities,” such as options and futures, which are key to program players’ trading games.
Kwalwasser added another reason why the NYSE feels no pressure to adjust the collar: “Nobody (among major program traders) has complained that they can’t do what they want to do” in the market because of the collar, he said.
Well, that’s not entirely true. Roy Neff, whose firm Cooper Neff & Associates in Radnor, Pa., is one of Wall Street’s hot young trading houses, argues that the collar has a definite restrictive effect on his ability to enter and exit the market at key times--meaning when activity turns hot and buyers and-or sellers are massing.
While the public is convinced that opportunistic traders like Cooper Neff are a detriment, Roy Neff sees it another way: He’s the risk taker willing to step quickly into market breaches--when too much stock is for sale, or not enough is for sale--and provide a stabilizing force by buying undervalued stocks or selling overvalued ones.
But with a market collar, Neff complained, “when the market gets out of line, we’ll be less able to bring it back in line than we otherwise could, because we can’t trade.”
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That argument has long been used by the big-buck traders, of course. But the fact is, their liquidity hasn’t been needed much since 1990, because the public appetite for stocks has been unprecedented. Restrictions on market volatility, it seems, have created a sense of security about stocks: Small investors see less volatility, so buying more stocks is an easier decision. The steady crush of new money has in itself dampened volatility by pushing the market up relentlessly.
The potential downside, however, is this: When the next bear market arrives, and today’s mass buyers become mass sellers, the NYSE collar will ensure that the market can’t quickly adjust to lowered expectations. Instead, said Merton Miller, the Nobel-prize-winning economist at the University of Chicago, “it will be death by a thousand cuts”--just as the Japanese stock market, a similarly collared market, has been ratcheting lower for four painful years.
Is a long, slow bear market better than a crash? Certainly, average investors will have longer to think about the bear market, and more time to act, with the collar. Will that feel better? Who knows.
To Miller, the real danger of collars is that people may believe they can protect the market from the inevitable. Ultimately, a collar is just a placebo, he said: “It doesn’t do any good. . . . As an economist, I’d get rid of the stupid thing.”
Shrinking Volatility
Since it was put in place in 1990, the New York Stock Exchange “collar”--which limits high-speed computerized trading when the Dow index moves 50 points--has been triggered fewer and fewer times each year, as market swings have died down.
NYSE collar triggers (number each year) 1990: 22 1991: 20 1992: 16 1993: 9
Source: NYSE
