Trading slump ‘wipes out’ recovery

A sustained slump in trading is threatening to wreck the nascent recovery at investment banks this year after many markets have failed to bounce back from the traditional summer slowdown, writes Tim Cave

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Revenues from sales and trading – which represent about three quarters of investment banks’ business – are forecast by analysts to fall by around 35 percent in the third quarter.

While there are optimistic signs of a recovery in volumes in some markets such as OTC derivatives and mortgage-backed securities, and the head of one US investment bank in Europe said he had seen a recovery to “broadly normal” conditions in September, most markets and analysts remain depressed.

Equities trading has been particularly hard hit, with trading volumes for stocks in the FTSE100 and S&P 500 indices falling 12 percent and 15 percent respectively in the third quarter compared with last year. Trading in the Hang Seng Index in Hong Kong is down 35 percent over the same period.

Trading in equities did not bounce back in September. In the first three weeks of this month, volumes on the S&P 500 and Hang Seng were 28 percent lower compared with the same period last year. Over the same period, trading volumes in FTSE100 stocks fell by 17 percent, while those in the FTSE Eurofirst 300, an index of the largest European shares, fell by 13 percent.

The slowdown, has hit several banks. Deutsche Bank said last week that third-quarter profits were likely to be “significantly lower” than the same period last year on lower sales and trading activities, and Richard Handler, chief executive of Jefferies, last week blamed “painfully slow” trading for a 26 percent fall in revenues in its latest results.
A slowdown in trading will be more harshly felt this year by investment because of the collapse in primary business: equity capital markets volumes are down nearly 50 percent in the US and Europe this year and M&A has yet to stage a recovery. In the first half of this year, the top 10 banks by sales and trading revenues generated 72 percent of their total income from trading, compared with 66 percent three years ago.

In a report on UBS, the banks team at Morgan Stanley last week said: “To be clear, we think the third quarter has very tough market headwinds for trading… cash equities volume remain weak in the third quarter and August”.

While equity indices have risen by about five percent to eight percent since the third quarter last year, this has not offset the collapse in volumes. Trading is also down compared with the second quarter of this year. Average monthly volumes in FTSE100 and S&P 500 stocks were down 19 percent and 16 percent during July and August, compared with average volumes in each month of the second quarter. Kian Abouhossein, banks analyst at JP Morgan, forecast a drop in fixed-income revenues of 38 percent this quarter compared with last year and a 35 percent fall in equities revenues.

Deutsche Bank’s Michael Carrier last week slashed third-quarter earnings estimates for Morgan Stanley and Goldman Sachs by 70 percent and 35 percent respectively “due to weak capital market trends across the board in the quarter.”
However, there are some signs of recovery, particularly in the derivatives markets. Trading volumes on the Chicago Mercantile Exchange were up 20 percent in August this year compared with the same month last year. However, the recovery in Europe has been more muted. Volumes for Eurex are up only six percent over the same period, and on Liffe volumes fell two percent.

Trading volumes in the US bond markets have been broadly flat in the third quarter this year, according to the Federal Reserve Bank of New York, although bond trading volumes from Deutsche Börse suggest a fall of about 20 percent to 25 percent over the same period.

Some analysts believe the slowdown could be overplayed. Abouhossein said last week: “The market perception by investors is in our view too negative, focusing on very poor cash equity volumes, assuming the rest of the business is similar. We disagree with this investor view, over-discounting a poor quarter – hence the third quarter could surprise. Segments of OTC products are holding up well, such as mortgages, rates and macro flow equity derivatives in line with seasonal movements.”

The growing fear in the industry is that the poor trading volumes could force many investment banks to reassess their business models. Banks refocused on client business last year after many of them wound down their proprietary trading activities. With fewer proprietary trading desks and hedge funds driving volumes, this has left many banks more exposed to changes in investor sentiment and flow business and has coincided with a drop in deal activity.