(Bloomberg) — The regular market for U.S. stocks runs for 390 minutes in a standard trading day. But at the rate things are going, eventually the last 10 may be the only ones that matter.
About a third of all S&P 500 stock trades are now executed in the last 10 minutes of the session, according to data compiled by BestEx Research, a developer of trading algorithms. This is up from 27% in 2021.
Now new evidence emerging from Europe – where the pattern is similar – suggests the trend could be hurting liquidity and distorting prices.
It is new ammunition for critics of the global boom in passive investing, because index funds promote the phenomenon. These products typically buy and sell stocks at the close, as the end-of-day prices are used to set the benchmarks they aim to replicate.
Assets in passive equity funds have grown over the past decade to more than $11.5 trillion in the U.S. alone, according to data compiled by Bloomberg Intelligence, increasingly shifting late-session trading. Active players looking to take advantage of this liquidity have followed, creating a self-reinforcing cycle.
The closing auction in Europe, which takes place after the end of regular trading, now accounts for 28% of volumes in public places, up from 23% four years ago, data from Bloomberg Intelligence and analytics firm big xyt show.
“The common knowledge is that closing auctions are very, very good mechanisms for closing markets,” said Benjamin Clapham at Goethe University Frankfurt, co-author of the new study. paper titled Shifting volumes in proximity: Implications for price discovery and market quality. “That may be true, but if we have such a shift in volumes in this last trading opportunity of the day, we could see price inefficiencies.”
The paper, which Clapham wrote with colleague Micha Bender and Deutsche Bundesbank researcher Benedikt Schwemmlein, focused on big headlines on the London, Paris and Frankfurt stock markets in the four years to mid-2023. The trio found that stocks generally move between the end of continuous trading and the last price set at the closing auction, yet 14% of this move is reversed overnight—a sign that it is driven by biased flows rather than fundamentals.
Closing auctions are making up a growing portion of European stock volumes.
The new research echoes previous studies, including in the US, where a 2023 paper also argued that movements observed during the auction are reversed overnight as a result of liquidity dynamics.
The charge is one of a number levied against passive investments, including one that can blindly inflate company valuations and wreak havoc when major indexes rebalance, causing billions in lopsided markets. The litany of concerns has inspired high-profile attacks from critics such as Elon Muskand most recently Greenlight Capital's David Einhorn.
But the extent to which any closing distortion should cause concern is uncertain and, as with so much in the modern market, the debate is not clear cut.
For Hitesh Mittal, founder of BestEx Research, overnight reversals are part of normal market function. Passive funds can buy at fractionally higher prices at the close, but he thinks the cost is “much less” than liquidity providers would pay for transactions of their size with lower liquidity earlier in the day.
In the US, the mechanism to determine closing prices operates alongside the last minutes of continuous trading. Nearly 10% of all U.S. stocks traded at that close last month, edging closer to earlier 2019 levels after falling in a retail trading frenzy, data compiled by Rosenblatt Securities showed.
Chuck Mack, head of strategy for North American trading services for Nasdaq, said market participants like the transparent price discovery and “depth of liquidity” at the close of auctions. He said US intraday liquidity is most affected by the increasing fragmentation of stock trading on different platforms.
Meanwhile, two other researchers – Carole Comerton-Forde at the University of Melbourne and Barbara Rindi at Bocconi University – END in 2022, the apparent European reversals may be due to noise in the open market, rather than distortions, and that intraday liquidity has not been damaged by the closing auction. Writing on behalf of the pair, Comerton-Forde said regulators had no cause for concern yet, “but should continue to watch this space in case things change.”
The London Stock Exchange did not immediately respond to a request for comment. A spokesman for Euronext acknowledged that price reversals occur in the wake of index rebalancing, but said “the reversals observed are typically modest and market overreactions are common following significant liquidity events.”
A spokesman for Deutsche Börse said that while there were differing views among market participants, the closure of auctions was not generally seen as a problem.
In the US, even as volumes shift at the end of the day, the growing role of retail investors has prompted a number of brokerages such as Robinhood to offer 24-hour trading of some securities to give them maximum opportunity to buy and sell . For institutional professionals, however, it's increasingly about those last few minutes.
“When I talk to portfolio trading clients who are more sensitive to these changes in liquidity, they're definitely going to wait,” said Mark Montgomery, head of business development at big xyt. “As liquidity decreases in the ongoing part of the day, the potential for them to leak information about their intent is much greater.”