Nasdaq, that young braggart of a stock market, is irrepressible. Good sense knocked nearly 40 percent off its value between March 10 and last Friday, April 14. But Nasdaq dusted itself off, swaggered back up to the bar, and ordered another round. It rocketed up nearly 600 points—more than 15 percent—on Monday and Tuesday.
During this Wall Street boom, Nasdaq has become synonymous with the tech stocks that are its highest fliers (its only fliers, in fact, but more on that later). It hosts Microsoft, Cisco, Intel, Sun, Apple, and most of the sexy dot-com startups and proudly dubs itself the "stock market for the digital world." Like the tech stocks it represents, Nasdaq uses the press to make itself look grand, portrays its modestly innovative business as a revolution, and practices the house religion of the Internet age: smugness.
Nasdaq was raised in humble surroundings. In the mid-'60s, the Securities and Exchange Commission decided that the market for small stocks not listed on the major exchanges was suffering because there was no reliable mechanism for sharing prices. With the SEC's blessing, the National Association of Securities Dealers opened such a centralized market in 1971. It was called the National Association of Securities Dealers Automated Quotation, and it was the United States' first electronic stock market.
Nasdaq was the trailer park of Wall Street. It welcomed small, young companies with no earnings, few shares, and low share prices. When a Nasdaq firm made it big, it quit the trailer park ASAP and moved up to the snooty gated community of the New York Stock Exchange.
D.C.-based Nasdaq was unfashionable but modern. It reinvented how a stock market works. At NYSE, buyers purchase from sellers in floor auctions. If buyers or sellers are scarce, a stock's designated "specialist" commits his own firm's resources to make the deal. The labor-intensive NYSE system relies on arcane hand signals, personal relationships, and lots of yelling. Nasdaq replaces the floor with the screen. It displays electronic quotes to all 500,000 brokers on Nasdaq. Buyers and sellers list their "bid" and "ask" prices online. Instead of having a single "specialist," each stock has several "market makers" who buy and sell, making their profit on the narrow spread between the bid and ask prices. Nasdaq made stock trading transparent, efficient, and democratic: Anyone with access to Nasdaq can see the prices and participate, more or less fairly.
In the mid-'90s, an SEC investigation nailed Nasdaq market makers for colluding to keep spreads artificially high, enabling them to earn windfall profits. (A market maker might buy 1,000 shares from a seller at $10 per share, at the same time as he was selling 1,000 shares to someone else at $10 ¼ per share, pocketing the $250 vig—a spread perhaps twice as great as it would be in an efficient market.) The SEC fined about 30 NASD companies $900 million and forced the NASD to spend $100 million to upgrade its in-house policing. The scandal made Nasdaq listings more transparent and caused Nasdaq to start measuring stock prices in sixteenths rather than eighths, cutting spreads 40 percent.
Nasdaq recovered from its scandal quickly, thanks to the technology boom. Like many Gen-Xers, Nasdaq was enthralled with computers, and tech stocks became its backbone. (Computer companies are 15 percent of its 4,400 issues but half its market value.) Companies such as Microsoft and Intel originally listed with Nasdaq because they had to. But they stayed with Nasdaq because they wanted to. Nasdaq's electronic efficiency jibes with the laissez-faire, technophile spirit of the computer entrepreneurs. The Big Board's arcane methods and clubbiness seem less trustworthy than Nasdaq's openness and egalitarianism.
The loyalty of the tech companies permitted Nasdaq's surge in the late '90s. When people discuss America's stock craze, they are mostly talking about the fascination with Nasdaq's computer and Internet stocks. The rise of online brokerages fueled Nasdaq: Internet investors favored the easy-to-trade, fast-growing Nasdaq stocks and talked them up in chat rooms. Nasdaq, not NYSE, hosts most of the IPOs that have made so much news. By 1993, Nasdaq's daily volume had surpassed NYSE's. Today, more than 1 billion shares are traded daily on Nasdaq. Three of the five most valuable companies in the world, Microsoft, Intel, and Cisco, belong to Nasdaq. The composite index climbed 40 percent in 1998, then 86 percent in 1999—a one-year record for a major stock index . When Nasdaq cracked the 5,000-point barrier in late 1999, some giddy analysts predicted that it would surpass the Dow by the end of 2000. The market value of Nasdaq companies remains less than half that of Big Board firms, but it is catching up.
Nasdaq gloats over its transformation from penny-stock backwater to epicenter of cool. It "thumbs its nose at NYSE," says Yale economics professor Robert Shiller, author of Irrational Exuberance. It treats the Big Board much the way Amazon.com treats Barnes & Noble, as an embarrassing archaism. Why, Nasdaq advocates ask, would you want NYSE's slothful chaos when you could sell stocks faster and cheaper electronically? Nasdaq is full of its hipness. It placed an enormous stock ticker in Times Square just in time for New Year's. Its TV ads are ubiquitous. It is planning its own IPO.
But like its overvalued tech stocks, Nasdaq is not as good as it seems. The index may have regained 600 points, but it has still lost one-quarter of its value. The success of Nasdaq runs shallow. About 60 of its 4,400 issues account for virtually all its 1998-2000 gains. Most Nasdaq stocks, like most NYSE issues, have been running in place.
Nasdaq's revolutionary image is also tarnishing. Many analysts have assumed that its better methods would triumph and force NYSE and any other competitors into the shadows. (After all, Nasdaq bought the American Stock Exchange in 1998.) But while Nasdaq calls itself "the stock market for the next 100 years," it may not survive the next 10. Just as any promising Internet startup soon finds itself competing with dozens of imitators, so Nasdaq is losing its chokehold on the electronic stock market. Since Nasdaq's mid-'90s scandal, investors—mostly large institutions—have traded Nasdaq stocks privately on "Electronic Communications Networks." ECNs, which are often owned by large brokerage firms, avoid the central Nasdaq price bazaar. ECNs list stocks privately, allowing brokerage customers to buy and sell without going through Nasdaq. They enable after-hours dealing, cut the cost of trading, and make it easier for institutional investors to buy and sell large blocs of stock without moving the price. In just three years, ECNs have grabbed 30 percent of Nasdaq's volume, and analysts predict they will soon own 50 percent of it. The NYSE is planning to start an ECN that will traffic in Nasdaq stocks.
Nasdaq seems confounded by the challenge. It tried to get the SEC to mandate a single "central limit order book," which would undermine ECNs by forcing them to list all their prices on Nasdaq. (Such centralization would probably benefit small investors.) The ECNs stifled that proposal, but Nasdaq still hopes to rein them in somehow. The stock market that prided itself on uppity boisterousness now wants to calm the markets down. It is becoming a middle-aged grouch.