What the Decline in Stock Holding Periods Means for Investors

Includes: DIA, QQQ, SPY
by: David Hunkar

Last month Mark Cuban wrote a provocative post on the stock market titled “The Stock Market is still for Suckers and why you should put your money in the bank." From the post:

“If you haven’t noticed, individuals are avoiding the stock market in droves. There has been an enormous exodus from equity based mutual funds. Why ? Because people buy stocks for only one reason, they want them to go up in price. If you don’t believe the market is going to go up. If you don’t believe you can find a greater fool to buy your stock, or the stock your funds own, why would you buy either ? You wouldn’t and people aren’t.

The amazing thing is that doing nothing in the market is the smartest approach to the market. It is pretty much impossible for some man or woman or child who devotes a couple of hours per week to the market to outperform the professionals who spend 24×7 doing this for a living and when they are asleep, they have a workforce full of people doing more of the same. In this day and age, none of us are smarter than the market.

I didn’t always think this way. I didn’t ever think there was a truly efficient market until just recently. What changed ? The availability of capital changed. While we can argue about whether or not the market is efficient because everyone has access to the same information, I would always argue that they didn’t efficiently use that information and even if they did, capital was not always allocated correctly to every market segment.”

I do not agree with his views. However, his piece got me into thinking about why many investors are avoiding the markets. In addition, some of my close friends have stayed clear of the equity markets for years and plan to stay that way. However, one need not completely ignore the markets. One can make above-average or sometimes excellent returns by investing in stocks provided they pick high quality stocks and diversify their portfolio.

Many years ago ordinary folks invested in equities to receive consistent and high dividends. Capital appreciation was considered secondary and people held equities for years. In the past few decades that has changed.

The following charts show the average holding periods for various exchanges over the years: (Click to enlarge)



Source: Patience and Finance, Andrew G Haldane, The Bank of England

Based on the NYSE index data, the mean duration of holding period by US investors was around 7 years in 1940. This stayed the same for the next 35 years. The average holding period had fallen to under 2 years by the time of the 1987 crash. By the turn of the century it had fallen to below one year. It was around 7 months by 2007.

Similar pattern exists in the UK also as shown in the chart above. There the average duration has fallen from around 5 years in the mid-1960s to less than 7.5 months in 2007.

Over the past 15 years even in international equity markets, holding periods have fallen. The Chinese market was red hot until few months ago. However the duration for the Shanghai stock market index is close to just 6 months.This shows that Chinese investors do not have a long term horizon.

Andrew went on to add the following:

“A decade ago,the execution interval for HFTs was seconds. Advances in technology mean today’s HFTs operate in milli- or micro-seconds. Tomorrow’s may operate in nano-seconds.

HFTs operate in size as well at speed. HFT firms are believed to account for more than 70% of all trading volume in US equities, 40% of volumes in US futures and40% of volumes in US options. In Europe, HFTs account for around 30-40% of volumes in equities and futures. These fractions have risen from single figures as recently as a few years ago. And they look set to continue to rise.

Asian is not immune from these trends. HFT is believed to account for between 5 and 10% of Asian equity volumes. In China, HFT is still in its infancy. But market contacts suggest as much as 80-90% of trading on the Shanghai stock exchange may be done by day-traders, many small retail investors. Impatience is socially, as well as technologically, contagious.

This evolution of trading appears already to have had an effect on financial market dynamics. On 6 May 2010, the price of more than 200 securities fell by over 50% between 2.00pm and 2.45pm.32 At 2.47pm, Accenture shares traded for around 7 seconds at a price of 1 cent, a loss of market value close to 100%. No significant economic or political news was released during this period.”

Hence investors worldwide do not hold their equity positions for long periods. These investors have fallen into the trap that the stock market is a casino where one can trade their hard-earned money and become rich quickly.

Disclosure: None