Trading Volume: Fear and Loathing on the Marketing Trail, 2014 by Salient Partners

I shared a dark suspicion that the life we were leading was a lost cause, that we were all actors, kidding ourselves along on a senseless journey. It was the tension between these two poles – a restless idealism on one hand and a sense of impending doom on the other – that kept me going.
Hunter S. Thompson, “The Rum Diary”

There lives more faith in honest doubt, believe me, than in half the creeds.
Alfred, Lord Tennyson

Preach the Gospel at all times, and when necessary, use words.
St. Francis of Assisi

Faith is the bird that feels the light and sings when the dawn is still dark.
Rabindranath Tagore, 1913 Literature Nobel Prize winner

Hold faithfulness and sincerity as first principles.
Confucius, “The Analects”

I’ve spent the past few weeks meeting Salient clients and partners all across the country: New York, California, Illinois, Texas, Minnesota, Massachusetts, etc. With four teenage or tweenage daughters at home I don’t mind the travel, talking about Epsilon Theory topics with smart, engaged people takes me back to what I loved about academia, and I find tremendous value in listening to what investment professionals have to say about markets today. Of particular note to me is how investment professionals are experiencing markets. What does it mean to be a professional investor or investment advisor in the Golden Age of the Central Banker? Two observations surprised me, and I believe they’re connected.

First, when I had these conversations six months ago I would get a fair amount of resistance to the notion that narratives dominate markets and that we’re in an Emperor’s New Clothes world. Today, everyone believes that market price levels are largely driven by monetary policy and that we are all being played by politicians and central bankers using their words for effect rather than direct communication. No one requires convincing that market price levels are unsupported by real world economic activity. Everyone believes that this will all end badly, and the only real question is when.

Second, trading volumes are abysmal. I know it’s summer, but this is more than just seasonality. Here’s a chart using data from my friends at Barclays PLC (NYSE:BCS) (LON:BARC) showing the 10-year trend in US cash equity volumes.

Fear Marketing Trail Cash equity share Trading Volume

Source: Barclays Capital (July 2014)

I love charts that require absolutely no explanation. Since the outbreak of the Great Recession, with a few exceptional months marked by panic selling, trading activity in US equity markets has done nothing but go down. And when you take into account the growth of algorithmic trading and other machine-to-machine activity, which now accounts for as much as 70% of daily trading volume, the decline in actual human beings buying or selling stock in order to acquire a fractional ownership share in an actual real-world company is much more dramatic than this chart shows.

But wait, there’s more. Here’s a 50-year chart (!) from my friends at Deutsche Bank AG (USA) (NYSE:DB) (ETR:DBK) showing the steady growth rate of trading volume in the S&P 500 (INDEXSP:.INX). With an r-squared trend line fit of 96%, this growth rate of 9.3% is an incredibly strong and stable pattern. Until late 2008 or early 2009, that is, at which point the pattern breaks like a thin, dead twig.

Fear Marketing Trail S&P 500 trading vol Trading Volume

Source: Deutsche Bank (July 2014)

How unusual is this 5-year break in the 50-year pattern of equity trading volume growth? Is this perhaps a transitory or random blip? Or maybe just a more pronounced version of a cyclical trough in trading activity.  Ummm … no.

Take a look at the chart below showing the degree of deviation from the trend line. Back in the 1973-74 recession trading volumes dropped slightly more than two standard deviations from the trend line. Today we are more than four standard deviations below the trend line, and the separation is steadily getting worse. The 50-year boom in US equity trading activity has not just stopped. It has reversed.

Fear Marketing Trail S&P 500 Cycles Trading Volume

Source: Deutsche Bank (July 2014)

Is this just an equity story? Nope. Here’s a 20-year growth trend and deviation chart for US bonds.

Fear Marketing Trail US Bond trading Trading Volume

Source: Deutsche Bank (July 2014)

Fear Marketing Trail US Bond trading cycle Trading Volume

Source: Deutsche Bank (July 2014)

This summer’s anemic trading volumes in both stocks and bonds are neither seasonal nor temporary. As you might expect, the Powers That Be at the bulge-bracket market makers are pretty freaked out and are pushing hard to generate some activity (not that we’d want any account churning, mind you). But all of these efforts announced from on high … all of the reorg’s and all of the revised compensation programs and all of the new investment platforms … it’s all just pushing on a string if there’s been a fundamental change in the behavior of advisors and investors. Unfortunately, that’s exactly what I’ve been seeing and hearing over the past year, and particularly the past few weeks. It’s a buyers’ strike, a massive “meh” about public capital markets, and it’s growing.

These two observations about the state of mind of advisors and investors today – a prevailing belief that market outcomes are driven by monetary policy (what I call the Narrative of Central Bank Omnipotence) and a lack of appetite to do much buying of anything – are two sides of the same coin.

The overwhelming perception I had of the advisors and investors I met over the past few weeks is that they feel as if they’re going along with some big charade. There’s a profound disillusionment with political and economic leaders … not that these leaders are necessarily incompetent, but that they are completely insincere. The advisors and investors I met – no matter how successful they had been over the past five years – were weary of the game and wary of being told what to think. They’re not suckers. They know they’re being played by Authority, whether it’s a

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