The Low Value in High Volume

Last week’s Quick Take highlighted that retail investors were being sucked into speculative trading.  This piece substantiates the following:

  • High turnover stocks have only outperformed low turnover stocks by this much in the bubble
  • High turnover is a possible sign of an unstable and/or speculative shareholder base
  • We hope we help RIAs, money managers, and consultants adjust their typically positive association with “liquidity” due to the highly anomalous moment we are in

Any money manager who has filled out a Request for Information from a consultant has dutifully calculated their portfolio turnover and analyzed the portfolio’s liquidity risk.  While the concept of estimating a portfolio’s liquidity risk can take a variety of methods, the concept is, at its core, simple.  Allocators and investors understandably want to have an estimate of the possible impact of large redemptions on the managers’ portfolios and/or how much the managers’ own buys and sells might influence the price of securities.

To grossly oversimplify the issue, people don’t want to see that large chunks of a given portfolio are in stocks that might require weeks or days to get out of.  That would indicate that a large redemption might cause losses for the remaining investors, or a large inflow might artificially inflate a given set of illiquid stock prices.  On average, people want to see reasonable liquidity relative to a given position.

Generally, we agree that this makes sense.  But today, we believe the extremity of circumstances merits peeling the onion back a layer.  We believe that high liquidity stocks are a risk factor and hope investors and allocators will be wary – what once was prized, liquidity, might now be a problem. 

The chart below shows the rolling 12-month returns of the stocks with the highest volume have soared to 116%.  Contrarily, stocks with the lowest volume returned only 35%.  Very simply, the stocks that people are buying and selling the most have shot the lights out.  Soaring price movements are now associated with large increases in volume.

Fig 1 Stocks with the highest turnover Are Up 116 A Level Last Seen in the Dot Com Bubble


A Volume Price Analysis: The Ugly Intersection of Positive Price Trends & Shares Traded

First, we would like to clarify how we define “volume.”  Our volume analysis uses the percentage of the number of shares outstanding that change hands every month.  So if a company has 100% turnover of its shares outstanding, that means the firm has effectively experienced the equivalent of being sold, in its entirety, in just 30 days.

We hope the absurdity jumps off the page at you.  When someone buys a stock as an investment, the holders of that security will own it for an extended period.  When a stock has elevated levels of turnover, it indicates the shareholders are speculators, not investors.  Therefore volume is an important indicator of the health and commitment of a firm’s shareholder base.

Figure 2 below shows


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