By Dan Strumpf
Volatility and trading volumes have collapsed this month as U.S.
stocks have marched to fresh records, a respite that few investors
foresaw and few expect to continue.
For now, the return to placid markets is being welcomed by
buy-and-hold investors who have been rewarded in recent years for
sitting tight. The Dow Jones Industrial Average notched its first
record close of 2015 on Friday, while the S&P 500 posted its
third record finish and the Nasdaq Composite is less than 2% from
its first record in almost 15 years.
Yet the February trading environment threatens to deal a new
setback for banks and hedge funds that make more money in bumpy
markets. Many bankers and short-term traders welcomed a raucous
January in which stocks slipped in heavy trading as price swings
widened.
Last year, stock-trading volumes increased for the first time
since the financial crisis, and the pickup carried over into
January. But in February, daily average trading volume slumped 4.8%
from the prior month. Two of the three slowest trading days of 2015
came last week.
Market swings have grown scarcer, and the CBOE Volatility Index,
a measure known as the VIX that uses options prices to predict the
magnitude of future swings in the S&P 500, has fallen to an
average of 16.6 in February, from 19.1 in January.
The shift means fewer opportunities for Wall Street trading
desks, which have been grappling with a business slowdown as a
result of tightening regulations and a market lull last year. Banks
hinted that the tumult in January led to a welcome pickup in
business.
For mom-and-pop investors and long-term fund managers, the
cool-down is a breather in a year that began with a laundry list of
worries: slowing economic growth around the globe, a potential
Greek debt default, collapsing oil prices and a looming
interest-rate increase from the Federal Reserve. Traders and
analysts credit the slowdown in market swings to stabilizing oil
prices and the European Central Bank's decision to spend at least
EUR1 trillion ($1.1 trillion) to stimulate the Continent's
economy.
"Some of the factors that created a lot of volatility that we
had earlier this year have, at least seemingly of late, seemed to
calm down, " said Jim Paulsen, chief investment strategist at Wells
Capital Management, which manages $345 billion.
Yet with the global growth outlook cloudy, uncertainty hanging
over Greece's European bailout, stocks trading at unusually high
valuations and the Fed still widely expected to raise U.S.
short-term rates this year, many portfolio managers are bracing for
a return of large market swings in coming months.
Some point to questions about economic growth in Europe, Japan
and China, while others fears that a clash between Russia and
Ukraine will escalate or that tensions will increase in the always
volatile Middle East. Mr. Paulsen thinks U.S. stocks will
ultimately have a flat year, with the market restrained by
relatively high valuations and an eventual Fed rate increase.
He isn't alone.
"Right now we are a bit fearful that valuations are stretched,"
said Randy Bateman, chief investment officer at Huntington Funds,
which manages $2.6 billion. The S&P 500 is trading at 17.1
times the next 12 months' earnings, its highest level since 2004,
according to FactSet.
In recent days, portfolio managers at the firm have been buying
protection against bigger swings in stocks in the options market,
in some cases on specific stocks and in others on broad market
indexes, Mr. Bateman said.
Last month, an average of 7.2 billion shares traded hands per
day, the highest level of trading activity for any month since
markets swooned in October. The Dow industrials closed up or down
by 1% 10 times during January, the highest total since October. By
the end of last month, the Dow was down 3.4%, its worst performance
in a year.
Reduced trading volumes often go hand-in-hand with a downturn in
market volatility. As market swings grow scarcer, investors have
less need to place new trades or shuffle existing bets. That
translates to reduced trading commissions for Wall Street
banks.
So far in February, the blue-chip index has seen a daily move of
1% just three times, and none since the first week of trading.
"It's like the quiet you get before a holiday," said Jesse
Lubarsky, an equities trader at Raymond James in New York.
Low volatility has often been an elixir for major indexes. In
July alone, as trading volumes collapsed and the VIX fell to a
seven-year low, the S&P 500 closed at a record on five
occasions. It did so another five times the next month.
"People definitely had an expectation that, coming into this
year, volatility would be higher than the last couple of years,"
said Joe Spinelli, who heads trading in individual stocks for the
Americas at Deutsche Bank AG. But lately, "volatility has been so
low, you haven't needed to do much. You can just kind of sit tight
and let your portfolio work for you."
Traders said much of January's volatility was driven by traders
moving quickly in and out of shares, rather than long-term
investors. After declining for years, activity by high-frequency
traders accounted for 46% of stock-market trades in January, up
roughly two percentage points from last year's average and up about
three percentage points from 2013, according to estimates compiled
by Citigroup Inc. That activity level has likely subsided again
given February's drop-off in volatility, according to the bank.
Exchange-traded funds, used to quickly trade broad baskets of
stocks, accounted for 31.5% of volumes last month, the highest
level since October, according to Credit Suisse Group AG.
"High frequency trading volume is coupled with volatility," said
Young Kang, global head of algorithmic products at Citigroup.
Saumya Vaishampayan contributed to this article.
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