Whither Equity Volumes?

Over the past 34 years, U.S. equity volumes declined only 4 times annually in 1977, 1988, 1990 and 2010. With U.S. equity volumes down 13% in 2010, people are wondering if volumes will grow in 2011? Unfortunately, I can’t answer that question, but I can offer up some observations on volumes to keep in mind.

·       Dollar volume is a better measure of activity than share volume. We tend to look at share volume because it is how U.S. market participants are paid and charged.  A better measure of activity is dollar volume, which reflects changes in the average share price. While U.S. volume decline 13% to 8.5 billion average daily shares in 2010, U.S. average dollar volume traded was up 6% annually to $225 billion per day in 2010 due to a 24% rise in the average U.S. share price across all stocks from $18.90 to $23.31.

·       Volume is highly correlated with volatility. Looking at the period from 2004 to 2010, there was a positive correlation of 73% between volume and volatility (measured by the VIX index) (See chart). The VIX has averaged 20.8 over the past 6 years and currently tracks at an average of 17.1 thus far in January 2011, contributing to lower activity levels today. On May 6th, 2010 the VIX spiked to 32.8 and 19.2 billion shares were traded that day, compared to the 8.5 billion ADV for all of 2010.   (Note: May 7th VIX was even higher at 40.95. ).

·       The ETF market is also included in U.S. share volume.In recent years, ETF trading exploded from 291 million average daily shares (ADV) in 2005 to 1,896 million ADV in 2009, accounting for 19.3% of U.S. volume. In 2010, ETF volume declined 25%, in part due to 2009 reverse splits in two actively-traded inverse ETFs (tickers FAZ and FAS). FAZ and FAS activity fell 57% in 2010 to 95 million ADV from 221 million ADV in 2009, although dollar volume fell only 32% in 2010. 

·       Individual stocks can have a significant impact on overall volume.The top 10 securities accounted for 15% of U.S. share volume in 2010. Citibank shares alone traded 574 million ADV, accounting for 6.8% of overall volume and 11.9% of NYSE-listed volume in 2010.

·       Watch the money flows.  Volumes are a reflection of money flowsincluding mutual fund flows, retail activity and the deal calendar. Over the past 20 years, equity mutual fund net new cash flow was negative only 4 times annually in 2002, 2008, 2009, and 2010, according to the Investment Company Institute (ICI). On a positive note, equity mutual fund inflows just turned positive for the first time in 6 months, with $826 million flowing into equity funds in December and $511 million in November.  Moreover, retail investors continue to enter the market with the ratio of Retail Daily Average Revenue Trades (DARTs) to total trades – a proxy for online trading activity – at its highest level in over two years (and possibly more) at 5.7% among the major online brokers that report such stats. And, the weekly American Association of Individual Investors sentiment index indicated that retail has been generally bullish (around 50%) about the market since October, but sentiment within the latest week of 1/26/11 turned more bearish (42.0% bullish, 23.7% neutral, 34.3% bearish). Finally, the deal calendar impacts future volume growth. In 2010, the capital raised on NYSE included $44 billion in IPOs and $193 billion in secondaries, and the pipeline for 2011 looks healthy.

·       Don’t forget seasonality. If trading was evenly distributed over the 12 months of the year, then we would expect to see about 8.3% (one-twelfth) of the year’s volume traded in each month of the year, but that is not the case. Looking at average daily volume trends from 2004-2010, the highest ADVs of the year were in October (106% of annual average) and January (105% of annual average) and the slowest months were August (92%), December (93%) and July (98%).  Clearly, summer vacations and holidays led to activity slowdowns, but this is not always the case, particularly if there is a volatility event.

As you think about volume growth in 2011, keep these observations in mind.