Financial Market Time Periods Have Compressed, Don't Expect It To Last

Whatever happened to long term investing?

Turnover on the New York Stock Exchange is now annualizing at 110%, where the total volume of individual shares bought and sold is 10% greater than the total shares listed the exchange. 10 years ago it was 88%; 20 years ago, 46%.

In 1980, turnover amounted to one-third of shares listed.

To put this in terms of a holding period, today's market participants buy and sell the entire Big Board once every 11 months, versus once every three years 30 years ago.

And with algorithmic, or computer-driven, trading propelling most of the volume (about two-thirds of total), it would seem unlikely that portfolio-churning abates anytime soon.

For corporate management, a 100% turnover rate effectively means confronting an entirely new shareholder list every 12 months.  For some companies, this list could change even more frequently, every nine, six or—gasp!—three months. And sometimes more often.

No wonder time horizons for strategic planning continue to shrink. Expectations simply aren't what they used to be. According to a recent study by Booz Allen, the global mean tenure of departing CEOs has dropped from 8.1 years to 6.3 years between 2000 and 2009, and the forced turnover rate for CEOs is 36.7%.

Maybe we should view time compression as symptomatic of machines taking over.  Investing and code writing, after all, now appear synonymous.

Just the other day, the Wall Street Journal profiled a group of twenty-somethings trading on Artificial Intelligence. While not boasting the seconds- or milliseconds-long holding periods of the high frequency variety, this fund still claims a 300% turnover rate, suggesting a primary (if not exclusive) emphasis on technical factors.

Perhaps, a 100 years from now, machines will even operate corporate C-suites, with A.I. guiding expansive enterprise resource planning ("ERP") systems.

What about the more immediate future? Is the market heading towards such extreme time compression that company and industry fundamentals disintegrate into irrelevancy?

Don't bet on it.

Back in February 2007, we wrote a lengthy article for the Lyceum newsletter Perspectives called "A Return to Long Horizons". It considered the overriding impact of technological advancements, and how they're manifesting in reduced transaction costs.

We argued that rapid-fire traders would crowd short-term strategies and create new opportunities for more patient investors. We pointed to advancements in information technology as causing the market to shift to short-termism, and their commoditization as causing the market to rebalance—eventually—to adopt longer time frames. Read it here.

Later that year, all hell broke loose, and market turmoil waylaid any sense of measured thinking among investor classes. Panic—don't we know—begets panic, and all money runs for cover.

Now, we think our thesis (outlined below) deserves another look—especially as financial regulation courses its way across market participants. (Regulators could do much better than the infinitely complex financial reform legislation to encourage a healthier marketplace and allow different investment strategies to compete. For example, they might simply have considered forcing banks to capitalize bonuses to foster greater ownership of risk-taking.)

From "A Return to Long Horizons":

The information revolution fundamentally altered the practice of money management, with commission reductions and the rise of absolute return investing becoming its consequences, rather than its drivers. Simultaneously connected, portfolio managers could better assess a data point’s validity, especially those who could act on its immediacy. Imagine a world without your Blackberry – now imagine it without any form of electronic communication. Better performance on better information attracted shareholder dollars. Greater buy-side power, whether under the guise of alpha or absolute return, then augmented market liquidity: sell-side transparency rose and transaction (or trading) costs declined. While the Internet unexpectedly advanced the quality and quantity of information, its success is now commoditizing information as access points proliferate and costs decline. Together with government regulation (fair disclosure and Sarbanes-Oxley), information’s evolutionary surge has turned to level the playing field – at least for those playing the trading game.

Here's a graph we drafted to illustrate our viewpoint.

© Lyceum Associates, Inc. All Rights Reserved.

In keeping with our theme, we're thinking long term. Short-termism could continue to compress financial markets even more tightly, but at some point the long-term folks will regain the edge.

And that's what matters most: that edge, where one investor class is able to achieve better returns at less risk to capital relative to other classes.

At the very least, the 2007-8 time period made it absolutely clear that absolute return is an absolute fallacy. Investing is a relative game, and we were right about that:

As prospective shareholders begin to rank money managers more by peer performance and risk-return conditions continue shifting against portfolio churning, margin-of-safety will replace absolute return as the buzz-phrase of the next five years.

So long as policy makers and regulators don't completely warp the marketplace, long-term folks will have their day once more.

Okay, we admit that might be an awfully large qualification.

For the market's stake, we're going to take it.