A woman becomes convinced her house is haunted. In case you’ve not seen it, I’ll save the twist, but it’s the twist that matters. Things are not as they seem.

Crack WSJ markets writer Tom Lauricella asked in a page one article Oct 18 if markets are cracked. Traders he surveyed said building positions in stocks is getting harder. Liquidity is thin. Spreads are rising. Getting trades done – completing an order to buy or sell shares within projected price ranges – is challenging now in the most liquid names.

In the movie The Others, the problem is perspective. The answer to what’s going on depends on how you look at it. Since we’re limited by the camera and the perspective of the central characters, the reality of the problem doesn’t manifest itself till near the end.

In markets, it seems like liquidity is the problem. But what if it’s a matter of perspective? Classically, liquidity is capital. Today it’s somebody on the other side of the trade. Are they the same? No. What’s on the other side of most trades? A machine. Why is it there? Incentives. It’s not there because it’s committing capital. It’s there because it’s paid to be there.

Don’t believe me? Look up exchange fee schedules and see the difference between rebates for adding liquidity and fees for consuming it. You can Google it.

About ten years ago when The Others came out, regulators decided brokers had too much power. Markets were decimalized and automated to marginalize brokers. The idea was good: Middle men were driving up the cost of investing so get rid of the middle men.

But referees shouldn’t determine outcomes. It’s like the problem in all time-travel movies: The moment you interact with someone, you alter every future outcome. Brokers own most of the dark pools and exchanges. There are TEN TIMES as many middle men now in the form of speculative traders changing prices daily. But exchanges don’t commit capital. Speculators don’t commit capital.

Do you wonder why there’s no liquidity? There is no liquidity because rules and regulations discourage committing capital to match up buyers and sellers, because there’s no profit except in 100-share increments. Add the value uncertainty that flourishes when 100-share trades resulting from incentives set prices for the whole market, and you soon won’t see block trades in AAPL.

Which brings us to the cost on the corporate balance sheet. Calculate your average intraday volatility. You can do it by going to any repository of your historical quotes. Subtract the daily low price from the daily high price. Divide that result by the closing price. The result is your intraday volatility percentage. Do that over 20 days. Average it.

Across our client base, average intraday volatility is over 4%. If you substitute intraday volatility into a common calculation of the equity cost of capital in place of beta, you will arrive at something very near the REAL cost of your equity, based on implied volatility.

You will be stunned.

A top-twenty US public company’s treasury department and we both found real cost of capital between 13-14%. That’s cheap compared to many, where the cost of equity capital is between 20-30%.

What it means in effect is that your stock price is materially lower than it should be because markets today consist not of liquidity – capital – but trading fragments for immediate profit.

In The Hours, the question is who is haunting and who is haunted. The same one exists in equity markets. By driving brokers from markets in the name of lower spreads – thinking that somehow low spreads equal liquidity – we have exploded the cost of equity capital. We have haunted our own markets.

The parties robbed by these rules are investors and public companies. The two most silent participants in capital markets.

How to solve this problem? If your stock doesn’t reflect multiples of cash flows and can’t seem to break out of repeating ranges and loops, it’s not you. It’s the structure. Maybe it’s time to speak up.

The hours tick.

Getting back to trading, how come some investors rail at churn trading, while others love machine intermediation? Somebody must be wrong, right?

Take Templeton Global Advisors, which runs about $100 billion. The president there, Cindy Sweeting, was a fellow panelist. They favor the low-touch, low-cost structure in markets today. With fast machines taking the other side of institutional trades, funds like Templeton can re-allocate portfolios fluidly across asset classes for 60% of the commissions they used to pay, and with abundant liquidity.

What’s more, machines create value opportunities, the Templeton folks believe. The propensity of money to run in algorithmic packs today, what’s called Macro Focus investing because it’s built around big trends and large scale risk-management, means sometimes this group or that sector are left behind. Templeton can swiftly allocate resources, feed out orders through card-shuffling automated trading systems, and blend a fresh investment hand in a new suite into the deck.

Sounds great. How come everybody doesn’t agree? Mason Hawkins at Southeastern Management somewhat famously opined to the SEC that “current market structure is flawed because unfair structural advantages permit short-term professional traders to insert themselves between long-term buyers and sellers. This intermediation conservatively results in $20 billion per year in execution costs and untold billions in opportunity costs for investors.”

One says costs are lower. One says costs are higher. Our point, and we do have one, is to give IR professionals answers. So, when somebody dashes breathlessly up on the street and bleats, “High Frequency Trading is bad!” And you reply, “that’s correct,” and then you turn, and Cindy Sweeting, a very smart and informed investor and a really nice person to boot says “we love it,” well, how to avoid appearing the fool?

The answer lies in the difference between liquidity and capital formation. We have reached an odd place in the capital markets where the interests of growing businesses and the objectives of institutional investors are at odds. Intel went public in 1971 at $23.50, and raised $6.8 million. Its market cap is $120 billion today. That’s capital formation. But in 2005, its market cap was $150 billion.

This is part of the “untold billions” Mason Hawkins meant. We have traded capital formation for the efficient movement of liquidity, and the two are not equal. For many modern global institutions, finding gaps and divergences that span months and weeks, combined with cheap trades and bountiful liquidity, is sufficient.

It can and will produce returns for nimble investors. If it didn’t, we would not have seen fundamental investment fall from 50% of daily volume a half-decade ago to below 10% now, while speculation, program trading have exploded. In some mega caps now, forms of fast-moving liquidity ranging from Templeton’s comings and goings to mathematical arbitrage account 95% of volume.

But it’s not truly investment, but more like the nexus of dislocation and intermediation. Market caps for many fine companies are stuck in neutral (there are always outliers). Money hasn’t forsaken equities; it’s morphed from buying low and selling high on fundamentals, to buying low and selling high on divergence.

And that’s the difference. High-frequency trading is not bad. It’s superbly efficient for moving securities from point to divergent point. But intermediation replaces capital formation. How many IPOs have you seen raising $7 million now? It’s not done, and so companies don’t grow anymore from tiny to giant, which is not only the heart of job-creation, but the root of investment, and wealth.

So when you’re asked why some like it fast and some don’t, you might just say, “The card shuffler revolutionized card shuffling, just like fast trading did for liquidity. So how come they don’t use automatic card shufflers in the World Series of Poker?”

Switching gears, I owe a mea culpa. We’ve berated the exchanges for fueling conditions that constrain real investment – fragmentation, rebates, direct access, sponsored access, high-frequency trading, flash orders etc, et al, since data and transactions are keys to exchange prosperity. But Duncan Niederauer’s interview in the weekend Wall Street Journal (see link below) was the best call yet for return to capital formation in the equity markets. I am now cooking up a comfort-food casserole of crow in the crock pot.  I did drop a note to Mr. Niederauer saying so, too.

A word on the markets and then let’s talk about the size of trades and why they matter to your IR efforts.  These renewed swings of a percent or more lately on major measures reflect forms of statistical arbitrage in which systems tweak assets and seek small gains, while all around the noise plays. We do not see anywhere that more than 10% of volume reflects conventional value investing.

Which leads us to trade size. SEC, we hope you hear this. Issues of all sizes and shapes reflect nearly the same number of shares per trade.  Say your stock trades 2,000 times per day and your volume is 375,000 shares.  You average about 190 shares per trade. If you trade 5 million shares a day and 27,000 times daily, your average trade size is…about 190 shares.

What’s wrong with that?  We’re coming to it.  Trade sizes are a consequence of best execution rules, which require brokers to work within standard deviation. In time, there’s little deviation, or you get fined. We’ve defined a single entry standard for a vastly disparate market of 10,000 different companies.

What happens? The moment an institutional algorithm begins to make trades that consume liquidity – or “take” it – someone else’s algorithm looking for rebates leaps in between.  Thus we have markets where everyone must make and take liquidity, which becomes in time an end unto itself. Seldom – about one out of ten times – are active participants able to do more than tweak positions.

Plus, costs for doing so are low.  Advocates of this system trumpet low costs as though that’s the Holy Grail. The Holy Grail is a fat pipe of IPOs. Seen that lately?

In fact, the cost of capital formation is extremely high.  If you trade 2,000 times per day at 190 shares per trade, any value institution will be front-run before it ever gets close to 200 trades, or 10% of your daily volume. How will this value investor own your stock?

Likely, in baskets or ETFs.  It’s hard for an institution to buy or sell your stock as an end unto itself, unless it’s a hedge fund.

Now wait, there’s good news too. We’re here to make you look cool in the IR chair, after all.

If before, institutions needed 100,000 shares to realize gains, now they need only 10,000.  How? Suppose your prospective institutional investor buys 10,000 shares on a given day, and you trade 2,000 times per day. You may be nearly assured of appreciation in the coming 2-3 days, because the activity ripples through your market structure, changing the math and the behavior.

So, message accordingly!  Remind institutions that smaller commitments may produce appreciation – the desired outcome. Capital appreciation can be had for less money, so to speak. Hey, it’s an imperfect solution to a perplexing problem of rules – but we’re trying!

How will you measure these effects?  Market structure.  Learn it, love it, live it, IROs.  Rules aren’t going to change soon.  That’ll take time, and let’s all keep fighting that good fight.