The accumulation of financial assets may be an investment in the personal perspective, but it does not mean that real capital comes into existence. Investing in stocks does not create more real capital. Most of the stock trade is a rotation of ownership. Higher stock market valuations appear as real wealth creation, but it is not the price of an asset that means wealth but the profits that come from the process of production. What counts for the level of wealth in the time to come is the future stream of income that results from the profit-generating entrepreneurial activity. Monetary saving is not necessarily investment, and investment is not automatically capital formation—Antony P. Mueller
In this issue
The PSE’s Brokerage Industry’s “Creative Destruction”: Online Platforms Take Lead as Retail Participants Chase Prices!
-“Creative Destruction” at the PSE Brokerage Industry: The Online Platform Dominates and The Coming Zero Bound Commission Rates
-Creative Destruction at the PSE: Demography is Destiny?
-Bells Ring at the Top? Retail Participants Chase Record Prices!
-Financial Tightening Pulls Down PSE’s Trading Volume, Divergent Headline and Market Internals
-Summary and Conclusion
The PSE’s Brokerage Industry’s “Creative Destruction”: Online Platforms Take Lead as Retail Participants Chase Prices!
“Creative Destruction” at the PSE Brokerage Industry: The Online Platform Dominates and The Coming Zero Bound Commission Rates
Last August, the officials of the Philippine Stock Exchange cheered on the growth spike of stock market accounts, which was the largest since 2008: “The number of stock market accounts broke past the one million mark based on the 2018 Stock Market Investor Profile report of The Philippine Stock Exchange, Inc. (PSE). Total stock market accounts reached 1,089,443, up by 25.4 percent from the 868,810 accounts in 2017. This was spurred by a 60.9 percent increase in the number of online accounts to 625,763 this year from 388,864 the previous year”.
Figure 1
The growth of online accounts, which solely spurred this extraordinary growth in stock market accounts in 2018, spiked by 60.9%! (figure 1, upper window)
Meanwhile, traditional accounts shriveled by 3.39%, the second contraction in three years. (figure 1, middle window)
With traditional accounts taking a backseat, the boom in online accounts has prompted a grab for dominance with 57.44% share of the stock market accounts pie!
Since the end of 2013, traditional accounts registered a .321% Compounded Annual Growth Rate (CAGR) compared to the breakneck 37.09% CAGR for the online segment. The disproportionate balance of growth exhibits the evolutionary structural shift in the business model for stock market brokerage.
This trend is a striking demonstration of the critical shift in the stock market’s brokerage model, representative of Joseph Schumpeter's “creative destruction” a process in which something new replaces something older.
While the traditional model won’t disappear immediately, it looks likely headed for extinction.
Another development from abroad tells us why: zero bound commissions.
From CNBC: “The race to zero appears to be nearing the finish line after several brokerage giants cut commissions on all U.S. equities, options and ETFs in the last few weeks. Interactive Brokers was among the first to drop trading fees – offering zero-commission stock and ETF trading via its Interactive Brokers Lite service since late September. But Charles Schwab really rocked the investment world by announcing zero fees across all stock trading last Tuesday – pushing rival brokers TD Ameritrade, E-Trade, Ally Invest and Fidelity to follow suit just days later.”
Should the globalization of financial markets persist, the newfangled model may be about to grip the world. In the local sphere, while commissions may not go to zero soon, it is headed lower.
Or bluntly put, since the PSE would have to compete with stock exchanges of other nations to encourage foreign participation in trading and ownership of domestic equities, in this light, to become competitive internationally, trading transaction costs would have to evolve towards international standards. Hence, not only will the zero bound commission rates kick-started by the US diffuse globally, it is likely to influence the cost structures of domestic equity transactions.
So domestic brokerages would have to shift and expand from providing trading platforms to the non-trading income models such as asset and cash management services and more.
What’s certain is that not only will the online boom produce the gist of the growth in the stock market industry, but its growth will also come at the expense of the traditional paradigm.
Creative Destruction at the PSE: Demography is Destiny?
Figure 2
The demographic distribution of trading participants underscores this trend of creative destruction.
The PSE noted that 64.6% or about two-thirds of retail participants came from ages 18 to 44, which dovetails with the same age group taking up 78.7% of online accounts. Meanwhile, the older age levels (45 to over 60 years old) constitute the meat of the traditional accounts.
The profile of the PSE's trading participants’ distribution of age and online usage corresponds with the national demographic profile bearing a young median age of 23.5 which underscores the nation’s demographic dividend.
And the smallest income level constituted the bulk of accounts, in the context of total and online accounts.
Yet, some numbers behind this critical transition.
The Philippine Stock Exchange lists 131 active brokers from which about 30 of them have assimilated the online trading platform. If, however, operating on the assumption that these online platforms have entirely abandoned the traditional model, then about 100 brokers will be competing for a shrinking share of a market dominated by the 45 to 59 and the over 60 age group!
The age groups comprising the bulk of the clients of the traditional markets haven’t been rigidly technology averse. Some have begun to adapt to online trading!
So while the competitive landscape would translate to a smaller broker segment chasing the growth market, on the other hand, the larger broker segment would have to contend over a diminishing market!
A receding traditional market and a booming online market, the trend towards highly segmented competition, and reduced profitability should translate to a shakeout of industry players.
Of course, neither does the adaption of online platforms guarantee an expansion of market share nor profitability.
In essence, demographics, the widening adaption of the online platform, competition and the zero bound commission model will fade the traditional brokerage platform.
And not only will brokerages have to embrace the online platforms to survive, but it would also require them to expand their business models to cover non-trading sources of income, such as asset and cash management and more.
Bells Ring at the Top? Retail Participants Chase Record Prices!
Though the 25.4% growth looked impressive on the surface, in perspective, 1.089 million stock market accounts would account for a measly 1.04% of the 104.256 million population as of 2017, or 2.4% of the estimated labor force population of 45.416 million as of July 2019.
Neither has the PSE identified the penetration level in the context of retail’s volume as % of the total or as of the GDP, nor the margin debt exposure for these classes and the aggregate.
And the timing of the growth surge should also be of interest.
Retail participants accounted for 97.5% share of the PSE’s total stock market accounts in 2018, this would be the highest level since at least 2010.
And despite the growth spike of retail participants, these numbers would hardly affect the dominance of financial institutions in the stock market’s trading volume. Institutional participants consist of a 2.5% share of the total.
Furthermore, women appear to hold a slight majority (+50.6%) of the online population. Have the domestic version of Japan’s Mrs. Watanabe or homemaker-traders begun to populate the retail trading arena?
Aside from the internet and marketing efforts by the PSE and of some of its broker members, what has drawn the public’s interest on stocks?
The simple answer: the PSYei at record high!
Figure 3
It’s no coincidence that with a seething run-up that delivered a stunning 25.11% return by the headline index in 2017, which culminated in a landmark 9,058.62 on January 29, 2018; retail interest soared during this period.
Perhaps goaded by the social media, along with peer pressure, retail participants bought into the momentum hype in the hope that the milepost apogee of the headline index would transform into a perpetual dynamic and deliver instantaneous prosperity to them!
With easy money come easy profits!
And these hapless neophytes were unwittingly finagled by establishment institutions, which had a field day of selling and redistributing equities to them at stratospheric prices at the height of a mania induced by the headline index.
Despite the scintillating 25.11% return by the composite index in 2017, considering 2009's 63% or 2010's 37.62%, the annual baseline return has been headed downhill. (figure 3 upmost window)
Before 2018, enormous returns hardly excited retail interests. Nor had the increased internet penetration level and burgeoning online trading seem to have whetted much the attention of retail participants during the heights of the headline index in 2015, 2016, and 2017. (figure 3 middle window)
So when the PSYEi pulled back by 12.8% at the end of 2018, guess who had been left holding the proverbial bag?
Oh, as a side note, the boom of the index at the start of 2018 propelled a surge retail enrollment at the PSE. However, the online platform virtually absorbed over 100% of it since the traditional model registered a decrease. If such a milestone wasn’t able to draw in customers to the traditional platform, how then will it cope in a bear market?
Financial Tightening Pulls Down PSE’s Trading Volume, Divergent Headline and Market Internals
And it must be emphasized that only a few members of the composite index were responsible for the index's pinnacle of 9,000, which had been a consequence of the runup from the end of 2017 until 1Q 2018. The mirage from the historic highs of the headline index performance hoodwinked retail participants into stampeding to open up of accounts.
And as proof of the degeneration of record performances, member participants to such feats have been dwindling: 16 in 2015, 12 in 2016, 9 in 2017, and also 9 in 2018. So when the PSYei 30 reached 9,058, only 9-issues were responsible for it.
And nor has it been a coincidence that the BSP-led 2018’s Financial Stability Report (p.13) reported on the PSE’s trend of falling profitability amidst the escalation of interest rate expenditures!
Hasn’t it been ironic, why the unfavorable outlook on the stock market in the first two (2017 and 2018) FSRs from two different BSP Governors?
[See Diokno’s 2018 FSR Report Warns on Bank’s Mounting Liquidity, Fund Mismatching, Settlement Fails and Concentration Risks; the BSP Chops RRR rates by 100 bps! October 6, 2019]
And here’s the thing. The decadent market internals didn’t operate from a vacuum.
Figure 4
Retail participants bought into the 9,058 as overall peso trading volume dropped substantially. Total peso turnover fell 11.74% in 2018, the third annual decrease since 2014. [figure 4 upmost window]
Yet, the declining annual peso volumes were ramifications of the tightening liquidity of the banking system, which is best demonstrated by the plateauing, and the subsequent cascade of the banking system’s cash reserves, and likewise, the cash-to-deposit ratio. [figure 4, middle and lowest window]
Figure 5
There is no such thing as a permanent free lunch.
The orchestrated propping up of the headline index, as exemplified by last week’s modest mark-the-closing pumps, translates to a loss of volume in the broader markets. [figure 5, upper window]
So the opportunity cost of the gaming the index has not only been to skew or to concentrate the market cap weighting towards the top 5 to 10 heavyweights, the dearth of volume have also induced an entropic performance over the market’s internals.
Relative to the share of the full market capitalization, the top 5 has 42.72%, while the top 10 has 63.95% of the pie.
And even if the headline index has been drifting at 7,600 to 8,000 in 2019, my radar screen of 197 (non-index issue) shows that less than 15% of its universe as operating in an uptrend. The best breadth for the year was 25%!
Sold as a bull market, the proportion of 75-85% either down or stagnant represents one?
The thing is, the headline index has been telling a contradictory story relative to its real health conditions. It’s an optical illusion.
Moreover, the unbridled index management reveals the extent of mispricing that has afflicted the market’s natural discovery process.
If the capital markets have been emitting grotesquely distorted signals, why shouldn’t this be reflected in the real economy through malinvestments?
Does the retail stampede herald to the ringing of the proverbial bell at the top?
Will the fund manager Bill Blain’s mantra of “The Market has but one objective: to inflict the maximum amount of pain on the maximum amount of participants.” To achieve its foul ends, the market sucks us in… and when so much money is sloshing around, just desperate to find something to do… then it gets so much easier..” serve as template of the future?
Summary and Conclusion
The number of stock market accounts boomed in 2018. Online accounts grabbed over 100% of the share of growth as traditional accounts contracted. Online accounts now consisted of over 50% share of the PSE’s total trading accounts.
US equity brokers jumpstarted the offering of zero commission rates last week. As stock markets compete for foreign exposure, such an icebreaker will percolate into a global dynamic that should influence even the transaction cost structures of domestic brokerages.
The nation’s young demography, combined by the deepening internet penetration level, has fueled the paradigm shift towards online trading. To cope with structural changes in the industry, domestic brokers would have to expand to consider non-trading income platforms like asset and cash management.
2018’s record high in the headline index catalyzed the spike in the growth of the PSE’s retail participants.
Retail participants chased prices even as market breadth deteriorated incited by falling peso trade volume. Contributing to this diminishing trade activity has been the banking system’s tightening liquidity conditions.
The divergence in the performance of the PSYEi and the broader markets, from the incessant manipulation of the headline index entails numerous opportunity costs: lower volume for the broader market which limited upside actions, mounting concentration risks from the narrowing of trading activities, patent mispricing, the decaying market internals and malinvestments in the real economy.
