Financial markets’ market bubble?

For the last few months, a selected group of US stocks has been performing exceedingly well, to the point of attracting the attention of the watchful eye of the Economist’s sharpshooters, who wondered (in the issue dated November 17, 2005) whether this was another instance of market mania. The group in question are the US financial exchanges: Chicago futures exchanges, CME and CBOT; International Securities Exchanges, the US market leader in option trading; Intercontinental Exchange (ICE), the parent of the International Petroleum Exchange (IPE) and last but not the least, the New York Exchange (NYSE), which is going public via a merger with a publicly listed Archipelago. All these exchanges have outperformed broad market averages and benchmarks. In absolute terms, their performance was remarkable as well: CME doubled in last six months and, since its IPO in September 2004, Archipelago’s market value has increased almost fourfold. Among large and well-known stocks, only Google has done better recently. However, in terms of market value, exchanges still have some way to go to catch with Internet heavyweights: CME is now worth some $13 billion and Archipelago, close to $5 billion.

For the Economist’s pundits, this performance of financial exchanges is “a bit of a shock.” Yet, for those of us, who followed the performance of financial exchanges in Europe, this is definitely not a surprise. In this particular area of financial services sector, Europe has been ahead of the US for some time already. European exchanges have been now listed for several years and, today, public listing is a rule rather than an exception, particularly for the major players: LSE, Deutsche Borse and Euronext. We analysed the emerging structure of European exchanges in a paper published in July 2003, where we noted that “Over the last two years [2001-2003], the three major European exchanges, London, DBAG and Euronext, have all performed better than the broad indices of their core markets.” Since then, the three exchanges continue to out-perform their core market indices. This is also the case for the OMX, which runs major Scandinavian and Baltic markets and which was the first exchange to be listed, as early as in 1987 (although since 2000, OM out-performance is less pronounced).

Thus, the good market performance of US exchanges should not be seen as an aberration. We expect it to continue, particularly as competitive and mergers and acquisition manoeuvres amplify, as they are bound to do. Relative to their European counterparts, US exchanges have at present rather narrow instrument coverage and confine themselves to trading, leaving aside the lucrative segments of market information, clearing and settlement. Clearly, financial exchanges have become full-fledged financial institutions. They no longer compete just with each other but also with their erstwhile customers and shareholders, large commercial and investment banks and securities brokers/dealars. As realm of markets grows larger every day, the battle to control their critical levers (pricing, transacting, transferring value) is likely to intensify. Exchanges may not win it but they (and their shareholders) are well-placed to benefit from it.

Search engine: leveller or tyrant?

In its last issue, dated November 17, the Economist discusses a recently published online paper by Santos Fortunato et al, which argues that search engines have an egalitarian effect on web traffic. This argument runs against a well-known thesis that search engines exploit the power-law nature of the web, which creates a winner-take-all effect, where high traffic sites attract more searches, which in turn generates higher traffic and so on…

Not surprisingly, one of the leading proponents of this thesis and author of a widely publicised paper about the “googlearchy,” criticised Fortunato’s argument for its methodological weaknesses. For some reason, I was unable to find the Hindman’s comments, so I cannot assess their pertinence.

My own view is similar to that of Jacob Nielsen, who argued that specialisation mitigates the power-law effect of search engines. In other words, search engines accentuate the traffic hierarchy in general sites but facilitate access and diversity in specialised sites.

Any one sided and general argument about the relationship between search engines and site traffic ignores the complex nature of the web. It is simultaneously a mass media and a set of specialised channels. In those channels, it is not only the use that it is interactive but also the content. Users construct the content of their sites dynamically through active and repeated search, some of its driven by search engines, some by random links and some by peer group referrals. Also, their use of search is becoming more sophisticated (multiple keywords, proximity and synonym search) and more purposeful. For instance, users of financial websites are no longer content with price quotes and agency press releases. They will look for less accessible information and research about their portfolios, relying on their peers on bulleting boards and blogs for addresses of little-known specialists and tipsters.

Because of this fundamentally segmented nature of the web, neither all the searches nor all the sites visits traffic can be considered as equal. Their value to the user (and to the site owners) differs considerably sometimes dramatically. This is reflected in the value of bids for keywords. While general keywords have become cheap commodities, worth few cents, specialised keywords are often highly valuable to the tune of tens of euros. Any serious research on the impact of search on the traffic should therefore also consider the paid search (in its various forms). Only then, research could be deemed useful and relevant for site designers and owners.