Monthly Discussion

What Is Happening to the NASDAQ and the NYSE?

Growth sustained over a long period of time usually takes place in a succession of well-defined S-shaped steps. While the size of the organism (species, product, company, etc.) grows along S-shaped patterns the rate of growth goes up and down along bell-shaped patterns. Moreover, during the low growth periods between curves, large fluctuations appear rendering this period rather chaotic see Exhibit 3 (for a full discussion see Chapters 2&3 of Conquering Uncertainty).

Cascade of Natural Growth Processes

Exhibit 3. This figure is reproduced here from Conquering Uncertainty. The graph at the top shows the amount of growth achieved during the filling of three consecutive market niches. The graph at the bottom shows the rate of growth, i.e. the life cycle for each process. The delimited regions represent "winter" seasons when chaotic fluctuations become prominent.

If we zoom out further so as to see many S-curves cascading, we are likely to discern a large-scale S-curve outlined by the long cascade. S-curves are nested like Russian dolls. A large curve can be decomposed in a succession of smaller ones, each one of which can be further decomposed in even smaller curves. For example, one typically finds many product curves in one company curve, many company curves in one industry curve, and many industry curves in one global-economy curve. Furthermore, the life cycles of the smaller curves become progressively shorter as we approach the extremities of the enveloping curve. The phenomenon of shrinking life cycles can thus be linked to the level of saturation of the enveloping process. For a family of products, shrinking life cycles indicate that we are approaching the exhaustion of the technology the products rely upon.

Competitive substitutions are also characterized by S-curves, and substitutions that last a long time may depict the pattern of cascading S-curves. In a substitution process the newcomer does not necessarily need to replace the incumbent entirely, as happened with cars for horses. Sometimes only part of the old niche becomes available for substitution. For example, Microsoft plus Intel replaced only half of the market value possessed by IBM plus DEC (see Conquering Uncertainty).

Now let us look at the NASDAQ and the way it has been taking over investment dollars from the NYSE. This substitution should not be expected to proceed to 100%. Moreover, the substitution shows the pattern of smaller S-curves succeeding one another, see Exhibit 4.

Exhibit 4. S-curves are fit on the data under the assumption that NASDAQ and NYSE compete for investors dollars the same way rabbits compete for grass. Annual data points are shown here but the analysis is based on daily data. Monthly data points are shown for the last two years (open circles). The data stop on March 31, 2000, but a quick check on April 18 places a point squarely on the read line. The thick white line is an artist's interpretation of what the overall process could look like.

NASDAQ's claim of market share during the last 20 years depicts four S-shaped steps on the evolution of a market defined as the sum of dollar volumes of NYSE plus NASDAQ (we neglect here the small in size and with rather flat evolution American Exchange).

In fact the pattern of successive S-curves also indicates a shrinking of the respective life cycles. The two early growth step, when NASDAQ's share grew from 15% to 40%, required seven years each. Since that time, there have been two more steps—the last one now approaching completion—with progressively shorter cycles. This is evidence that the enveloping process (the macroscopic S-curve sketched in by the thick white line) is approaching its ceiling. My feeling is that there will be no more growth steps in this process, and perhaps a short decline eventually stabilizing NASDAQ's share at around 2/3.

The NASDAQ for NYSE substitution is then one more completed growth process. With NYSE's volumes (both shares and dollar) also reaching ceilings (see An S-Shaped Trail to Wall Street) I want to re-iterate here my conclusion of last June that we are up against stagnant markets. It should come as no surprise that recent fluctuations of both the NASDAQ and the NYSE have been breaking daily records both upward and downward. These fluctuations constitute neither crashes nor corrections. They simply reflect the chaotic nature of markets missing a well-defined long-term trend, be it bull or bear.