Challenge of a market that does not shout: Nasdaq's rise may signal a long-term shift in US investment. Larry Black reports

'HUNDREDS of billions of dollars change hands here, but it still comes down to two brokers meeting face to face,' wrote Bruce Duffy, a financial pundit, in an essay commemorating the 200th anniversary of the New York Stock Exchange last year. 'I trust a market when I can hear it breathing,' he added.

But in the months since that anniversary, the 'Big Board' has been overtaken by a market that doesn't breathe or, for that matter, shout 'buy' or 'sell'.

In January, for the first time, more shares were traded across the electronic quotations system operated by America's National Association of Securities Dealers than passed among the order-pads and computers of the NYSE's specialist floor-traders.

And the contest has not been limited to market volumes: since the bicentenary, big NYSE industrials such as General Motors, IBM, Westinghouse and Sears have been dropping while small over-the-counter shares have surged ahead to new records in the US, gaining almost 25 per cent since October.

Despite the NYSE's relative decline, the value of the trading that goes on each day at the corner of Broad Street and Wall Street still remains double that of the NASD's Automated Quotations system. And last week, after three months of relative stagnation, the NYSE's blue-chip index, the Dow Jones Industrial Average, finally set a new record of its own, rising to an all-time high of 3,416.74 on Thursday, partly at the expense of Nasdaq stocks.

But many on Wall Street believe last week's catching up by the Dow is only a lull in a longer-term shift by both investors and companies towards the over-the-counter market - a shift that will be exaggerated by further market deregulation some time this summer.

Evidence of Nasdaq's challenge to the NYSE is plentiful. In contrast to London's Unlisted Securities Market and other secondary markets, Nasdaq is attracting bigger players, and growing twice as fast in dollar volume as the NYSE. Last year it overtook the Tokyo Stock Exchange as the world's second-largest equity market in dollar terms - dollars 890bn to dollars 484bn - and likewise left London's International Stock Exchange (dollars 531bn) far behind.

In a telling sign of the times, last month saw IBM - long the bluest of the NYSE's blue chips - fall behind Nasdaq's Microsoft in total market valuation. Similarly, financial futures markets, looking for a reliable barometer of American corporate performance, are increasingly turning to Nasdaq's 100 instead of the Dow or the NYSE's broader Standard & Poors 500 Index.

Nasdaq's 4,000 issues also include more foreign companies than all other US markets combined, listing the American depository receipts of 88 companies, among them Reuters, Telefonos de Mexico (Wall Street's most actively traded stock for much of last year) and, more recently, UK technology firms such as British Biotechnology.

Part of Nasdaq's success story is the new-found interest in small stocks after a decade that saw Wall Street first mesmerised by giant corporate takeovers and then scared into the arms of reliable earners such as consumer products and big exporters. Moreover, smaller companies have traditionally prospered under Democratic administrations.

'If you ask where one finds the value of corporate America, you have to be persuaded that the S&P 500 still represents that,' the president of the Chicago Mercantile Exchange, William Brodsky, said last month.

'But if you talk to people about where growth potential is, they're going to say it's in small and medium-cap stocks.'

Another explanation for Nasdaq's success is the fact that it no longer contains only small stocks. In the 20 years since the market's establishment, start-up computer firms such as Apple, Microsoft and Intel have joined the ranks of the Fortune 500, as have other over-the-counter listings including the cable television giant Tele-Communications, and MCI, the big long-distance telephone carrier.

Indeed some analysts argue that these companies have become the true symbols of American industrial vitality, replacing the tired conglomerates that have become such a drag on the 30-stock Dow Jones Average.

Recent changes in the Dow component list, with declining industrials, for example, replaced by service firms such as Disney and McDonald's, have not gone far enough, says Peter Canelo, principal market strategist at County NatWest USA. 'If Intel had been substituted for IBM 18 months ago, the Dow would be at 3,600 instead of 3,400,' he says.

But maturing American companies no longer 'graduate' from Nasdaq to the Big Board. Despite the NYSE's claims about the superiority of its auction-specialist market over its rival's quote screens, many Wall Street brokers say Nasdaq's lower costs and faster execution have made it the market of choice.

And the growing effectiveness of the Securities and Exchange Commission has quelled the fears of 'Balkanisation' of equity markets expressed when America established its national market system in 1975.

There are important disadvantages to trading through Nasdaq, some of them related to the absence of the market-making specialists who step in to provide liquidity when order imbalances would otherwise halt trading. But most of Nasdaq's drawbacks - illiquidity, as well as volatility and riskiness - are increasingly the drawbacks of trading in any small stock at a time of heavy demand, particularly from unusually large buyers.

But the NYSE retains other advantages over its rival, including regulatory protection for its monopoly over trading in most of America's largest firms. Big Board members are banned from trading off- market in the shares of any company listed before 1979. And de-listing requires a two-thirds majority of a company's shareholders.

This summer, the SEC is scheduled to present a long-awaited review of equity-market regulation, and these two NYSE rules may well go by the wayside, despite ferocious lobbying efforts by William Donaldson, the chairman.

The challenge for the NYSE then will be to show that, all things being equal, its order-driven, face- to-face market is indeed more efficient, reliable and safe than an electronic market where buyers and sellers never know each other.

Losing the NYSE's protection will not stop the brokers breathing on Broad Street, according to market analysts. But it will for the first time allow investors to decide on the real value of having a floor under their feet.

(Graphs omitted)