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April 30, 2001

Grin and Bear It? The picture of market making may appear grim. But there is hope amidst the carnag

By John A. Byrne

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  • Grin and Bear It? The picture of market making may appear grim. But there is hope amidst the carnag

Market making is growing in leaps and bounds.

In the face of declining profit margins, a majority of U.S. market makers polled by Traders Magazine said they plan to increase the number of OTC stocks in which they post two-sided continuous markets.

That was the same message that emerged last year from the majority of respondents in the annual survey for this magazine. And market makers lived up to last year's 12-month projections: Dealers' current OTC list of Nasdaq, Bulletin Board and Pink Sheet stocks dwarf their year-ago numbers.

All told, 60 percent of market makers this year project increasing the number of Nasdaq and the other OTC stocks they trade in the coming 12 months; 33 percent project no change while seven percent expect to decrease the number of stocks they trade.

Bear Carnage

This year's Traders Magazine survey polled in several categories (see charts). It comes in the midst of bear market carnage and numerous pessimistic forecasts. It also marks the introduction of decimal pricing on Nasdaq which, as expected, has resulted in spreads getting squeezed.

For their part, many market makers do not think there will be a stock market downturn this year. Altogether, 64 percent said they are optimistic about a sustained stock market rally before year-end. (A little more than half said the Nasdaq Composite Index would hit 2,500 and above in this period.)

By contrast, last year's survey was conducted in the midst of Nasdaq's historic leap towards its chart-topping level of just over 5,000. What's more, the majority of market makers in 2000 reported profit margins had either improved or improved dramatically for the 12 months ending March 31, 2000, while a majority reported sizeable jumps in their net returns.

In a startling change, the exact opposite is reported in this year's survey. Profits margins are off - get this - at 87 percent of the desks that responded while net returns on trading revenues are down at 70 percent of them. The picture is indeed grim if the results are taken at their face value.

Singing the Blues

While many pros note that market making is generating much more revenue - and in many cases bigger returns - than in previous periods in the 90s, some market makers are singing the blues.

"We've had to do much more trading now to make money," said Tony Broy, chief executive of Nasdaq and OTC market marker Hill Thompson Magid. "The percentage of stocks we are taking losses on today is up by 50 percent."

In this view, the huge growth in market making is a simple case of economics.

"Market making is becoming a matter of scale," said Dan Burke, a brokerage industry analyst at Gomez Advisors in Waltham, Mass. "Market makers want to get their arms around more activity to help make up for the declining margins."

Andrew Madoff, head of Nasdaq trading at Bernard L. Madoff Investment Securities, which is projecting a 50 percent increase in market making - from 200 Nasdaq stocks right now to 300 in 12 months - concurred. He noted that with less trading in some individual stocks, there is more capacity to handle additional stocks.