Is the US market all it's cracked up to be?

Last year was the London stock market’s quietest in over a decade. According to EY data, just 23 issuers listed, down from 45 in 2022. Further exits could follow in 2024, and the pull of a US listing continues to worry the City. 

Last year, the world's biggest building materials supplier, CRH (CRH), moved its primary listing to the US, pointing to the opportunity for “increased commercial, operational and acquisition opportunities”. Polling company YouGov (YOU) is also considering a move, citing America's appetite for marketing data. Although these drivers are company-specific, there are more generic motivations, too. 

Gambling group Flutter (FLTR) started trading on the New York Stock Exchange (NYSE) at the end of January, and now intends to move its primary listing to the US later this year. The board believes that doing so will unlock long-term benefits by “giving the group access to much deeper capital markets” and “providing greater overall liquidity in Flutter shares”. The pull of the highly liquid US market is strong. But is it all it’s cracked up to be? 

Why liquidity matters

In very simple terms, liquidity describes how easily an asset can be bought or sold in a market, at a price reflecting its intrinsic value. If you bought a share for $20 and were immediately able to sell it for the same price, the market would be very liquid. But if you found yourself unable to sell it at all, it would be a sign that the market was entirely illiquid. Liquidity is hugely desirable when it comes to equities: the more liquid a market is, the more easily investors can respond to changing market conditions by entering and exiting positions.

But like so many simple-sounding concepts in economics, the reality is rather more complicated, and there are different ways of measuring market liquidity. One is the bid-ask spread. The bigger the gap between the seller and buyer’s demands, the less likely they are to agree on a price, and the less likely a transaction is to occur. A narrow bid-ask spread implies more transactions and higher volumes – meaning greater market liquidity.

Share turnover provides valuable insight, too. This measure compares the number of shares that did change hands over a period with the number of outstanding shares that could have changed hands over a period. The higher the turnover, the more liquid we assume the market to be. According to research from Nasdaq, the US market trades around $363bn each day – more than four times the liquidity of all European markets combined. 

But the US has many more listings, and many more big companies, which can give a misleading impression of liquidity. Nasdaq chief economist Phil Mackintosh points out that even though Apple (US:AAPL) trades around $10bn a day, the stock looks far less liquid once size is taken into account. Trade in Apple shares equates to around 0.82 times its market capitalisation each year. A far smaller company, such as American Airlines (US:AAL), may trade only $396mn per day, but this is equivalent to 10.5 times its market capitalisation. 

When you adjust for company size on a national level, something similar happens again. Although the US trades the most value of all countries, it looks like less of a leader when it comes to turnover. Japan, which has a heavy concentration of smaller microcaps, seems to have consistently higher turnover than the US. The UK still lags behind. 

This matters to boards, because higher liquidity is associated with higher valuations. Last month, Liberum analyst Joachim Klement highlighted a recent study on the relationship between liquidity and company performance. The research found that when higher liquidity decreased the bid-ask spread by one percentage point, company valuations increased by an average of 0.13 percentage points. This is more significant than it sounds: as Klement notes, the study authors use market cap divided by total assets as their valuation measure, meaning the increase would be larger than this figure if a price/earnings valuation metric were used instead. 

Still, Klement warns that “trying to improve stock valuations by moving to a more liquid market may not be the best lever to pull”. Improving governance by one ‘notch’ on the ISS board quality score, for example, can increase valuations by a meatier 0.22 percentage points. Although this requires serious changes in oversight, it is at least “under the board’s control”. The pull of the liquid US market might be strong, but there are gains to be made far closer to home, too.