I recently wanted to watch a video of myself on the IC website. Not a vanity project, but to see whether I’d mastered the new software; there was no sound! I knew what I’d said and am quite good at lip reading, having been diagnosed with impaired hearing in my 20s. The more I thought about it, the more I realised how much speech, music, sounds of the city and countryside, shooting and bombs add colour for a more rounded picture.
Volume, of the turnover kind – and the old-fashioned noise of face-to-face dealing – is also important in financial markets. I think this is currently being distorted for various reasons. I’m not alone: The Bank of England’s Financial Stability Paper Number 42 published in July 2017 looked at feedback loops in market-based finance (investment funds, dealers, insurance, pension and wealth funds) because banks today account for just half the UK financial system.
Turnover in top-quality bonds shrunk dramatically because of quantitative easing, trillions’ worth of paper withdrawn from circulation – permanently. Those who usually buy these instruments – life assurers and pension funds – whose inflows are swelling, are forced to pay up amid dwindling supply; they hold the paper until maturity. In fact, the Bank of Japan currently owns an estimated 40 per cent of all outstanding Japanese government bonds, so commercial banks own very few of them, cutting off the simplest way to boost profits or restore balance sheets – borrowing short-term cheaply and investing in super-safe long-dated paper that yields more. You can also see why fixed-income, currencies and commodities trading desks have seen profits tumble lately.
Equities too have seen trillions in stock permanently removed from circulation, share buybacks the culprit here. Pre-1982 in the United States these were classed as ‘market manipulation’. Later that year the Securities Exchange Commission decided this was not so, unleashing a deluge of corporate profits diverted into buying back their own company’s shares – and lining management’s pockets handsomely. It is estimated that in the US alone since 2003 at least $7 trillion has been spent this way. Department stores JC Penny and Macy’s have spent more on buybacks than their businesses are currently worth.
INSEAD professors Ayes and Olenick studied 269 companies who had carried out buyback operations and concluded: "Buybacks are a way of disinvesting – we call it committing corporate suicide – in a way that rewards activist [hedge funds] and executives, but hurts employees and pensioners." Triple whammy as dividends are reduced, research and development cut, fewer shares are available so earnings per share rise. The Swiss National Bank, allegedly the biggest ‘hedge fund’ bar none, bought assets equivalent to 125 per cent of GDP to prevent currency appreciation.
Rarity value is easily understood, reflected in the $400m paid last week for one of just 20 paintings by Leonardo da Vinci. Or as the old saying goes: buy land, they ain’t making it any more. Scarcity, though, is a double-edged sword because few transactions mean no one’s sure what anything’s worth. Buyers then make derisory bids for fear of being duped, and sellers are deluded into asking silly money for an asset they’re not even sure they want to sell.
Thin markets can lead to overtrading, attempting to make a predetermined return on lower turnover. It also means that big orders cannot be executed, so fund redemptions are suspended.
