A volatile stock market is often compared to a roller coaster – a silly comparison that crumbles under the slightest scrutiny. For a start, the fun of a roller coaster ride comes from plummeting downwards with frightened abandon; the steady incline is just something that you have to put up with. Try telling an IRO that they should be enjoying the day’s 20 percent slump in their company’s stock price and just see what response you get.
The other howling flaw in the analogy is that roller coasters are examples of clinical engineering. They are bywords for human control and predictability. Not so in the case of stock market volatility. These days you haven’t got a clue what’s going to happen. Look at the year so far. The progress of some stocks charts a graph that would make you sea-sick just looking at it – heck, some of the trajectories would loop-the-loop if the laws of quantum physics didn’t make it impossible.
Of course, volatility is nothing new. It’s always been one of the key characteristics of the equity market. If it wasn’t, people wouldn’t play the game. ‘I don’ t think there’s anything wrong with volatility,’ offers Robert Conway, a technology sector analyst from PricewaterhouseCoopers in London. ‘With high risk comes high reward. If investors don’t want risk, they should put their money in a building society or property stocks.’
Fair enough, but there’s volatility and then there’s volatility. In April, US equities were 2.26 times as volatile as US bonds, according to Lehman Brothers – the most extreme figure for more than a decade. Figures from the Leuthold Group, a Minneapolis – based investment research firm, state that almost half the trading days in the first quarter of 2000 (48 percent) saw daily fluctuations of 1 percent or more in the Standard & Poor’s 500 index. That’s almost two and a half times the median for the past 100 years.
The Nasdaq composite index rose or fell at least 1 percent almost three-quarters (73 percent) of the time. That’s more than four times the median of 17 percent over the index’s 29-year history. Steve Leuthold, chairman of the Leuthold Group was moved to say, ‘This year’s volatility is unprecedented.’
The thing is, a volatile environment affects more than just the size of an IRO’s ulcer. It spreads a blanket of fear (or at least apprehension) that covers all market participants. For a start, the IPO sausage machine has discernibly slowed with Vodafone Pacific, Shopcreator Developments, Project Telecom, Yes TV and TeleCity pulling floats in the first half of the 2000 in the UK alone. India has also seen a raft of offerings stumble at the last minute due to the specter of volatility.
Similarly, in May, Zee Telefilms, India’s largest new media and broadcasting group, opted to cut the size of its proposed ADR issue by two-thirds, citing volatile market conditions.
The spate of volatility is also curbing the merger mania that has characterized corporate culture over the last few years. According to Thomson Financial Securities Data, the flow of mergers and acquisitions has slowed sharply after record levels in the first quarter of 2000, partly as a result of stock market volatility. While the total value of deals on the global M&A market rose 26 percent to a high of $1,882 bn in the first six months of the year, only $760 bn of that occurred in the second quarter.
The major factors
Maybe this slowdown will chill things out a little. After all, it seems that years of consolidation and an adjustment of the corporate landscape have been major factors in the rise of volatility. ‘There have been some really large amalgamations of companies – such as the Vodafone and BP deals,’ says David Gould, director of investor services at the UK’s National Association of Pension Funds. ‘That’s had a distorting effect.’
Of course, there are other reasons. A spokesperson for ING Barings claims that the comparatively small percentage of shares listed in IPOs also encourages wild swings. In Japan the average free float this year for IPOs has been 18 percent. When Deutsche Telekom floated T-Online, its internet arm, 9 percent of shares were made available.
Meanwhile, online trading has made it easier for ordinary investors to deal in shares. ‘Momentum’ traders, who follow a particular share minute-by-minute as it rises, have typically found the richest pickings in the technology sector.
‘With retail investors trading online, there are many more jump in / jump out investors,’ says Tom Hills, assistant treasurer and director of investor relations at Procter & Gamble in Ohio. ‘Although I do think it’s more of a problem for new economy stocks.’
And participants in the new economy don’t mind saying so. ‘Volatility is a challenge but then it’s the nature of markets,’ says Peter Bancroft, head of corporate communications for Psion. ‘We’re stuck in the middle of the convergence of the telecoms and computing technologies so we get caught up in the macro trends of both industries. Volatility is just something we have to live with.’
Time was, of course, volatility was exclusively the scourge of these technology, media and telecom stocks. But now even old economy stocks have gone wobbly. On one day in March, Proctor & Gamble saw its stock price fall 31 percent. During the same week France Telecom zoomed up 26 percent. J Sainsbury’s average price change in that month was more than 4 percent – higher than at any time since February 1975. Indeed, on 15 March more than half the stocks in the FTSE 100 had daily moves of more than 5 percent.
A Bad Thing
And for a whole bunch of companies that is worrying. The reason that excessive volatility is A Bad Thing is that it impacts on the primary function of capital markets: that of raising money. High volatility, if sustained, is said to scare away investors and reduce liquidity. Companies, which are becoming increasingly dependent on the markets for financing, then find they can no longer get the capital they need.
Surprising volatility is bound to provoke an outbreak of mass caution among investors but, as Procter & Gamble’s Hills explains, caution and hysteria are very different things. ‘Our stock price suffered a hit in March,’ he says, ‘and we had another bump down in June. But investors haven’t been scared away totally – they’re waiting on the sidelines to see what happens. In fact, an analyst said to me recently, We know that you’re going to get back on track but we’re just going to keep an eye on things for a couple of months.’
So investors don’t exactly freak out at the sign of volatile market conditions then? ‘I think you have to differentiate between institutional and retail investors,’ argues Conway. ‘Retail investors generally see risky stocks such as technology stocks as a quick way to an easy gravy train and they react badly to volatility. They’re often quite naive, although there are some very sophisticated retail investors.’
A study by Harris on behalf of Charles Schwab doesn’t support the suggestion that retail investors are prone to fleeing, though. The poll, conducted the day after an especially volatile April 6, found an overwhelmingly 94 percent of Schwab’s investors remained comfortable with their investment approach. Only 12 percent say that the recent volatility has shaken their long-term confidence in the stock market. According to the Hewitt 401 (k) Index, 401 (k) investors have also been largely unaffected by recent stock market volatility, transferring a daily average of 0.06 percent of the $62bn of assets tracked by the index during the especially volatile April.
Bad reputation
And yet there remains a lingering perception – particularly in the media – that private investors are easily scared and give flight at the merest hint of danger. Such a sentiment prompted an angry letter to the Financial Times from a Mr David Tuffs.
‘Sir, With reference to your report (‘Carphone to tackle ‘stagging’ ‘, June 20) on the impending flotation of Carphone Warehouse, I find it incredible that retail investors may be prevented from selling their shares for three months but the institutions will not have the same restriction… To imply that volatility in the share price just after flotation is due largely to retail investors ‘stagging’ the issue is nonsensical.
The volatility seen in the first few days after Lastminute.com’s flotation was caused almost entirely by the institutions ‘ditching’ large numbers of shares, many of them seeming to relish the opportunity to do so at the expense of the retail investor.’
Similarly, Bancroft doesn’t see Psion’s retail investors as particularly flighty. ‘They’re well-informed and have generally done their homework,’ he says. Indeed, Hills claims that, if anything, it is the institutions that are the problem. ‘Institutional investors demand shorter time horizons,’ he says. ‘I think retail investors recognize our company’s potential longer- term value. They’ll look at the price, get in and hold.’
As for the future of the market, when will we see a return to relative calmness? ‘The short answer is that volatility is here to stay,’ reckons Gould. ‘It’s just a fact of life these days. With even more amalgamation we’re seeing the creation of even larger companies – especially in industries such as pharmaceuticals with big cash needs.’
And Gould believes the effects of continued volatility will be quite profound. ‘I think indexes such as the FTSE 100 will fall out of favor and be replaced by wider-looking indexes that aren’t limited to single countries,’ he opines. ‘We already have European indexes and global indexes. We’ll see new indexes that expose high class stocks.’
He suggests that other factors might affect volatility, too. ‘It’ll be interesting to see how the effect of the stock exchange amalgamation [between London and Frankfurt] will impact on things,’ he remarks. ‘There’ll be large groups offering 24-hour trading. It will be a continuous conveyor belt.’
What to do?
In the meantime, though, there must be something the IRO can do to smooth things a little. ‘You just have to make sure that your story is understood as well as possible by both the media and investors,’ says Bancroft. ‘In fact, the media is particularly important as it’s the media that informs a lot of retail investors. It’s unlikely to do much about volatility but it can limit the reaction to it.’
‘In short, there’s nothing that companies can do,’ considers Gould, more pessimistically. ‘Although it helps if they have a long-term approach and can show a clear strategic direction, a solid board and a willingness to put money into R&D.’
The key, suggests Hills, is honesty and realism. ‘A lot of companies go through a drop in price and blame it on stock market irrationality,’ he considers. ‘Our interpretation is that there are very good reasons for the bump, such as our growth prospects and capitalization.’
And so, after a difficult few months, an emphasis on solid communication is at the forefront of Procter & Gamble’s IR push. ‘Our belief is that by having a coordinated plan and through organized transition we can set about confidently rebuilding,’ says Hills. ‘We’re in a fortunate position. We have $3.6 bn of after-tax earnings power.’
For thrills and spills, your roller coaster has nothing on a volatile stock market. To compete with the unpredictable thrill of the market, you’d need a roller coaster without a track, without safety harnesses and without an adherence to the laws of gravity. It’d be stressful, nauseous and scary. But they’d probably employ an IRO to stand at the front and calm everyone down.
