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 For much of the year, ultra-cheap cash and faith in a recovering
global economy has kept equities on the rebound. In the first half
of 2015, trading volumes jumped 36 percent worldwide, according to
the World Federation of Exchanges, though the rise was a far more
modest 5 percent after stripping out mainland China's rollercoaster
stock market.
That in turn has helped banks squeeze out more trading revenue
despite pressure on all sides from increased automation, intense
competition and post-crisis regulation. First-half equities revenue
grew 18 percent at the top 10 investment banks, to $25 billion,
according to data from research firm Coalition.
But after last month's China-fueled spike in the VIX volatility
gauge to its highest since 2008-2009, flows are drying up and major
indexes like Japan's Nikkei or the S&P 500 are making daily moves of
3 to 8 percent.
"Volatility is generally good for trading desks but when you see
Japan up 8 percent overnight, or Wall Street down 400 points ... The
risk is just too much," said Mark Ward, head of execution trading at
Sanlam Securities in London.
"Volatility like this is horrendous. It's volatility on steroids."
It may already have inflicted some pain, albeit manageable, on
investment banks. While curbs on risk-taking have reduced banks'
exposure to proprietary trading, J.P.Morgan analysts warned last
week that August's bruising sell-off may have led to losses and
dented future trading and deal flows.
"Investment banks are not immune to the market movements," they
wrote in a note to clients. Beyond hits to profitability, the
analysts forecast double-digit falls in equities and fixed-income
revenue for the third quarter.
The surge in the market's fear gauge is blamed on fundamental and
technical factors alike. China's slowdown is alarming markets at the
very time when the U.S. Federal Reserve is weighing its first
interest-rate hike since the 2008 meltdown, while trend-following
algorithms exacerbate losses.
Whatever the cause, global equities fund flows are now in negative
territory year-to-date, according to BofA-Merrill Lynch research on
Friday. Investors are complaining of "untradable" markets and a
perceived lack of liquidity, strategists said, even if a big shock
to the system has yet to materialize.
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"The increased volatility and (Fed-related) uncertainty ... has
reduced flow to a trickle, with both the single-stock traders and
derivative sales reporting a paucity of directional volumes,"
Deutsche Bank Managing Director Nick Lawson wrote in a note to
clients on Friday.
It is still too early to say whether the current turmoil will derail
a recovery in trading revenues.
"It's not a hugely positive sign for volumes to pull back so quickly
after such volatility ... But this might be a slight pause as
opposed to a reversion in the trend," said Craig Viani, Vice
President at consultancy Greenwich Associates.
Industry watchers say losses are likely to have been in the
manageable range of $50 million to $60 million. The jury is still
out on whether the most active hedge funds will retrench, said
George Kuznetsov, head of research at Coalition.
In many ways, the safest bet is on volatility itself. Crossbridge
Capital's Manish Singh said he was using volatility-linked
derivatives to trade on the Fed's policy meeting next week.
"Whether the decision from the Fed is to hold or tighten policy ...
expect volatility to remain elevated," said Deutsche Bank's Lawson.
(Reporting by Lionel Laurent; Additional reporting by Atul Prakash;
Editing by Ruth Pitchford)
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