Feast or famine?

Traders are returning from summer to the prospect of more difficult trading conditions due to lower volumes. As uncertainty over the global economic outlook reigns, it may be time to reassess execution options.
By None

Labor Day, celebrated by both the United States and Canada on the first Monday in September, signifies not only the end of the North American summer but also brings to a close the mid-year meanderings of the global financial markets.

Lehman Brothers brought a summer of shredded nerves to a shattering halt a week or so after Labor Day 2008, when it announced its failure on 15 September. In 2009, the summer months saw the equity markets drift gently upwards as participants accepted that the global economy had stepped back from the brink of the apocalypse. This year, the markets have been sleepwalking into a slump in asset values and trading volumes.

Now that most equity traders are back at their desks, lower volumes are a growing concern. The volatility that accompanied the Greek government debt crisis and the ”flash crash' that temporarily wiped US$1 billion off the value of US stock prices led to a peak in trading activity in May. In Europe alone, trading volumes surpassed €1 trillion for the first time since October 2008. According to Thomson Reuters' Equity Share Market Reporter, total European equity trading turnover reached €1,108 billion in May.

But a welcome summer lull appears in danger of turning the markets comatose. By August, European turnover had almost halved from its May peak to just €668 billion, barely higher than the €597 billion traded in August 2009.

The picture is scarcely brighter elsewhere. In 2010, Asian trading volumes have not come close to last year's high of US$1,912 billion recorded in July 2009. Indeed, July 2010 was one of the lowest-volume months of this year for Asian equity trading, with total turnover of US$1,197 billion, although activity picked up in August, rising to US$1,464 billion.

In the US, NYSE Euronext reported average daily volumes across its cash equity platforms of 2.6 billion shares in July 2010, a 7.2% fall compared with the same period 12 months ago and 12.6% lower than the previous month. In addition, the S&P 500 slipped by almost 5% in August.

This is not a downward spiral that speaks of a massive sell-off, rather it suggests that only minor adjustments are required to portfolio strategies put in place earlier in the year and no great restructuring is needed while the consensus macroeconomic outlook remains cautious. The flow of economic data and corporate earnings statements will dictate how long the prevailing sentiment will last, but traders must get on with the business of dealing in a drowsy, low turnover market for the time being.

Market impact is harder to avoid when fewer players are in the market of course, but what strategic adjustments must the buy-side trading desk make should current market conditions persist? The depressed outlook for volumes has already claimed one scalp, with Nasdaq OMX shutting down its multilateral trading facility on 1 July on grounds of an unfavourable business climate. And the timing of a bid enquiry for Chi-X Europe, presumed by many to have been made by BATS Global Markets, which owns the rival BATS Europe, has been noted as a further indicator of pessimism over European trading volumes. Fewer choices of venue will inevitably require adjustments to order routing and may in time increase trading costs. In Japan, meanwhile, commissions have already begun to edge up in recognition of the need to cover the cost of research and other services from the sell-side at a time when volumes are struggling. Even in geographies where this is not the case, best execution may come under pressure from a restriction in the number of brokers used for execution services as institutional investment firms attempt to look after their most valued relationships.

At this point in the rebuilding of major western economies, forecasting an end to the downturn in equity values and trading volumes would appear to be a risky business, so it may be as well to dig in, prepare for the long haul and reassess the situation at Thanksgiving – that’s the one celebrated in the United States (on the fourth Thursday of November), not the Canadian feast on the second Monday of October!

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