All that glitters / The mausoleum of financial assets
The vanishing volume of trade on the Tel Aviv Stock Exchange is bad news for everyone.
Last week something rather strange happened. Amid the breaking news about the second bailout for Greece and reports of Israeli institutional investors cuddling the bruised IDB group and soaking up its newly issued shares, between dire reports about Partner Communications' earnings warning and the conclusions of the economic concentration committee - up popped Prime Minister Benjamin Netanyahu, declaring, "We have the best stock market in the world."
Netanyahu isn't the man to miss an opportunity to say something good about Israel, and while about it, about himself as its prime minister. He therefore extended a warm embrace to the chairman of Bloomberg, Peter Grauer, who dropped by the Holy Land for a visit with a little surprise in his pocket.
Bloomberg is a news company that also supplies particularly advanced trading data systems to financial players. Thus it happened that during Grauer's visit somebody sat down, tapped at the keyboard and produced a table showing how well the stock markets of the developed economies performed over the last 10 years - after factoring in risk, meaning, after division by the volatility of the share prices. And here we have it: Israel came in first out of 24 nations, bringing toothsome fodder for a prime minister starving for some positive reinforcement.
"This is a tremendous achievement, due in part to us taking the Israeli economy and extracting it from a state of being very concentrated," Netanyahu gushed.
He seems to be claiming that under his stewardship, the Israeli economy was rid of its disease of economic concentration, which means, domination of the economy by a handful of powerful business forces.
Eyebrows surely rose up and down the land.
One might remind him that the calculation goes back 10 years, while actual deeds to reduce economic concentration in Israel will only begin in the future, if they happen at all. During the last 10 years the Israeli economy was horribly concentrated, as described in the report just issued by the economic concentration committee.
It might also be apposite to remind Netanyahu that some of the last 10 years were dreadful ones for the stock markets of the developed economies, because of the great financial crisis, while emerging markets did beautifully. Also, non-Israelis - certainly over the last 10 years - tend to think of Israel as a developing market, not a developed one.
For another thing, the calculation is flattering. The reality is that the Israeli stock market was sluggish. It just didn't move much. And when volatility diminishes, the measurement of risk comes in low. Therefore, returns divided by risk are higher. The very lassitude of the Israeli stock exchange in the last 10 years makes it look a lot better in this narrow calculation.
One could even descend to pettiness and claim that this measurement over 10 years is meaningless. It measures a period that is over and gone, and meanwhile in the last year the benchmark TA-25 index of Israeli blue chips lost 16% of its value while the American benchmark, the S&P-500 index, gained 6%.
But none of that nitpicking is necessary. To show Netanyahu that the Tel Aviv Stock Exchange is sick as a dog, all that's needed is to show him the graph tracking the daily volume of trade.
During the last year, daily turnover has shrunk by 50%.
That's not a typo. Trading volumes have halved in the last 12 months, from about NIS 2 billion a day to NIS 1 billion.
Another year like that and we might as well shut down the TASE altogether and hang a sign on the door that says "Mausoleum of Financial Assets," traders grouse: High school kids can visit it and bring flowers to the grave site after going to the Haganah Museum nearby on Rothschild Boulevard.
But what happened? Why have trading volumes in Tel Aviv gone and vanished? Here are some of the reasons.
1 Foreign investors have headed east. Why? No real reason, but the trend around the world is that trading volumes in developed countries have fallen and investors are putting their money in the east. This is not an Israeli story; it's the story of every economy that isn't growing by more than 5% a year.
2 Israel's risk has risen. Bloomberg has systems to measure the risk inherent in a given capital market based on volatility and standard deviations, in keeping with finance theory taught in schools. But the real risk is a lot simpler to grasp. Trading volumes in Tel Aviv started to fall as the Arab Spring gained momentum, and continued to contract as the crisis in Europe escalated to a boiling point. In recent weeks, volumes have fallen even further because of the tensions between Iran and the West, and specifically Iran and Israel trading threats.
The increase in risk is evident in the cost of insurance covering government bonds - credit default swaps (the seller of the CDS agrees to compensate the buyer in the event of default ). U.S. government bonds are the benchmark, being considered safe as houses. In the recent past the spread between Israeli CDS and U.S. CDS was 1.4%. Now it's 1.9%.
What those figures boil down to is this: Trading volumes in Tel Aviv have been shrinking as investors become increasingly worried about getting stuck with a portfolio of securities during an escalating crisis.
3 Regulation is causing consternation and confusion.
Last year the governor of the Bank of Israel, Stanley Fischer, decided nonresidents should also pay tax on their capital gains from investment in makams (short-term Bank of Israel notes ) and government bonds. He did that in order to dampen their massive speculation in the currency market, specifically on the shekel-dollar exchange rate. Fischer surely took into account that the regulatory change would affect trading volumes, and it did.
Some of those currency speculators had also been dabbling in other Israeli securities, and simply decided to wind down their activities in Israel, in whole or in part.
Another new rule prohibits institutional investors from rolling the cost of investment in passive (non-managed ) investment vehicles called exchange-traded notes onto customers.
Exchange-traded funds and notes are a way to invest in a whole index without buying the actual assets, shares or other financial assets, themselves. Instead of buying shares of each company comprising the index, you buy shares of the ETF, which itself does buy shares of each company comprising the index. Nobody manages investment by ETFs: They invest in the index on automatic pilot. If a company enters the index, the ETFs buy its shares and if a company exits the index, the ETFs sell the shares. That's why the management of these investment vehicles is called passive.
But if institutional investors stop investing in ETFs because they can't roll over the costs onto their clients, then the ETFs have less money to invest in the companies comprising the index - the underlying assets. Thus the new rule depressed trading volumes.
Also, new rules governing investment advice have boiled down to deterring advisers from pushing investors to keep making changes to their portfolio.
4 Israeli institutional investors are investing more overseas. If a single trend stands out, it's that they're diverting money from Israeli investment to overseas opportunities. Some of the insurance companies are investing more than 30% of their managed assets overseas, and that's money not going to Israeli financial assets.
5 The rise of the machine:In recent years, more and more traders are using automatic software programs, rendering a lot of little day traders obsolete.
This number may be hard to grasp, but it's accurate and true: The proportion of automated trading out of all trading on the Tel Aviv Stock Exchange has reached 60%.
Yes, only 40% of trade in Tel Aviv is done by people who think, make decisions and tap on keyboards.
On Wall Street, the proportion of automated trading has reached 80%.
Since machines already exist that analyze the news and its implications, the day may soon come when all trading on the financial markets will be automatic, devoid of that human touch. It will be algorithm versus algorithm and may the better programmer win.
6 People have lost the faith.
Every time another stock market scandal comes to light, more people drop out of the game. Haircuts. Defaults. Nasty surprises (like Partner Communications' financial statements for the fourth quarter and the year 2011 ). Conflicts of interest everywhere you look. That horrible suspicion that the financial statements don't tell the true story. The bottom line of all these things is uncertainty, which depresses investment.
When you suspect the game is fixed and that the big boys are playing with cards up their sleeves, there's no point in playing the game. If you don't have the tools to price a security properly, buying it isn't a good idea.
All these factors together have hurt everybody relying on trading in securities for their livelihood - banks, brokers, traders and active investors.
But has the decline in trading volumes hurt savers, people in the game for the long term?
Sadly, the answer is yes. The lower the volumes of trade on the Tel Aviv Stock Exchange, the greater the chance that financial assets will be wrongly priced. It becomes easier to manipulate asset prices, and the costs of every action become higher too.
In its essence, a stock market is just like a used car market. Everybody knows that a Mazda 3 is a better investment than a Land Rover jeep, because there's a market for Mazda 3s: You want to sell, you can.
Nobody wants to buy a stock for top price, pay heavy fees for buying and selling, and when the time comes to sell - nobody wants the beast.
If trading volumes on the Tel Aviv Stock Exchange continue to dwindle, that is exactly what is going to happen to the savers and investors in Israel.