Friday, September 7, 2012

Equity trading volumes in the US continue to shrink

As as sign of sharply declining share trading volumes in the US, the broad measure of exchange volume computed by Bloomberg (below) is at a level not seen since 2008.

US total exchange volume 180-day moving average (MM shares; source: Bloomberg)
Tape A, B, C on all US exchanges (exchange symbol US) plus OTC (exchange symbol UV) and OTCBB (exchange symbol UU) trading volume for all security types.

There is a great deal of debate about the reason for this trend and what it means for the market in general. One of the common explanations has been the fact that market volatility has declined recently, bringing trading volumes down with it.
WSJ: - Thankfully for many people, volatility is rather benign these days, which could explain why volumes as well are quieter.
The chart below shows S&P500 historical volatility (180-day moving window). Recent period volatility is indeed low, but it's by no means the lowest in the past 10 years. The relationship between volumes and volatility is not at all obvious.

S&P500 180d historical volatility (Bloomberg)

Another explanation is that retail investors, burned by a series of market shocks, are simply staying away.
USA Today: - Part of the reason volume is low is because retail investors have been turned off by stocks, says Ryan Detrick of Schaeffer's Investment Research.
Some view the retail investor staying out as a bullish sign. In the past retail involvement has been a fairly reliable contrarian indicator.
Credit Suisse (via Business Insider): - "We stay overweight of equities and raise our year-end S&P 500 target to 1,500 from 1,425 - introducing a mid-2013 target of 1,520," he writes. "We think weak volumes imply a high chance of a sharp move in markets - it could be up!"
But there are a couple of problems with viewing low trading volumes as a bullish sign. One is that the retail investor exit may be more of a structural change that is here to stay. Retail investors continue exiting equity mutual funds for example, in part replacing them with index ETFs (see discussion). This year alone, some net $68bn left equity mutual funds. That means betting on retail investors piling in all of a sudden - as they have done in the past - may not be prudent in this environment.

The other reason the contrarian bet may be premature is that some institutional participants such as hedge funds have also been less active in the market. The latest ISI Group Survey of hedge funds shows them to be on average underinvested (long or short). It's not all retail driven.

Whatever the case, declining volumes will be important to watch going forward. As the Volcker rule pushes dealers to cut inventories further, poor liquidity in some shares may quickly become a serious problem.
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