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The amount of penny stocks traded on US exchanges has surged, with 557 trading in December.
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The jump comes after the SPAC bubble crash triggered a drop in share prices for many firms.
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It’s creating market inefficiencies and luring retail traders away from potentially better investments, experts say.
Though the brief frenzy around speculative startups is done for now, the bubble’s collapse may have broken market norms.
There are now hundreds of US-listed firms that trade below a dollar, a majority of which started as special purpose acquisition companies, or SPACs, that went public in the boom time at the height of the pandemic and before a regulatory crackdown triggered a bust.
As of early December, 557 US-listed stocks were trading below the $1 mark, a seismic uptick from the few dozens that existed in 2021, The Wall Street Journal reported. In fact, about one-sixth of the Nasdaq Composite is now made up of penny stocks, as the exchange is popular among small-cap issuers.
As these stocks remain listed on major exchanges, it’s a trend that’s leading to market inefficiencies, IEX Chief Market Policy Officer John Ramsay wrote in a post last week.
The ultra-low price of a penny stock makes elevated trading volumes significantly easier to achieve, compared to an stock that’s more expensive.
High volumes lead to capital distortions, as exchanges tend to consider a firm’s total share volume when offering incentives, as opposed to their price.
“By actively trading a stock with a price of around 19 cents per share, a firm could generate 1000 times more trading volume with the same amount of capital than it could by trading Apple,” Ramsay said in an example.
The “rebate tier system” encourages trading at very high volumes Ramsay said. It gives incentives for a trading firm to trade stocks that provide the “biggest bang for the buck”, which results in better pricing for the firm’s other trades.
The Securities and Exchange Commission has proposed to restrict this practice on the grounds that it creates an anti-competitive environment. The argument is that eliminating rebate tiers would do away with exchange inefficiencies, as capital flows wouldn’t reward stocks that game prices.
High volumes also give sub-dollar stocks a false of sense of attraction among retail investors. It’s problematic as these assets are already known for volatility and high-risk.
“High trading volume influenced by factors other than the fundamental value of listed companies can absolutely increase the risk of substantial losses to investors who may not be able to discern the reasons for that higher volume,” Ramsay told Business Insider in an email.
A report from Jefferies notes a similar dynamic.
“Stocks around $1/share have become popular with retail investors thanks to social media, so one might reasonably ask whether they are foregoing investments in other names – e.g., S&P 500 – and opting for sub-$1 stocks instead. And if so, how might that impact liquidity in other more traditional stocks.”
It also doesn’t help that these assets remain included on indices, as it provides them with a “badge of legitimacy,” Ramsay added.
Though Nasdaq requires firms meet a $1.00 threshold for their shares to continue trading, companies below that level are given a 180-day grace period to conform. It’s led to a surge in reverse stock splits, a move where a company decreases its share count to boost the price.
255 such splits occurred in 2023, compared to 159 the year before, Jefferies said.
“Given the lackluster U.S. IPO market, it’s quite reasonable to see how exchanges would want to help companies remain publicly listed,” Jefferies said.
Read the original article on Business Insider