From a Deutsche Bank note quoted on FT Alphaville:
Equity volumes fell persistently from their 2008 highs through late 2009. They have since hovered at low levels around half their peaks, with brief spikes during the summer risk-aversion episodes. Bond trading volumes have fared better, but are also running well below normalized levels. What has driven these dramatic declines in volumes and when and what will turn them around?
A long list of factors argues that the decline in volumes is structural: a longerterm decline in risk appetite after the severe 2008-09 sell off and “lost decade” of zero ten-year equity returns; the aging of the baby boom generation; the growing importance of ETFs and “black pools” reduced single stock and exchange volumes; regulatory changes prompted declines in broker inventories and prop trading; and “de-equitization” (bigger buybacks, fewer splits and lower issuance) which has kept shares outstanding flat for the last 10 years versus strong growth over the previous 30 years.
But the fall off in volumes could just as well be cyclical. It would be reasonable to expect that volumes peak at the onset of recessions as investors de-risk, but confidence in the recovery and conviction return only slowly; thus trading volumes turn up with a lag. A deeper recession and a slow economic recovery mean a bigger decline and longer recovery time for trading volumes.
The cycle in equity volumes: this time does not look different. Historically there has been a clear trend in equity volumes since the data is available in 1967. Trend growth has been 9.3%, with mean-reverting cycles around this normalized run rate. Looking at the cyclical component, i.e., the deviations from trend run rates, in our reading:
This volume down cycle has been large but is not unprecedented. The decline in volumes below trend has been a 2 sd move, but it is comparable to those seen before: in the 1970s, the early 1980s and in the early 1990s. Volumes reverted back to trend run rates after each of those episodes. So the size of the current decline does not by itself indicate a structural break;
The down cycle has been in line with the broader macro cycle. The cyclical component of volumes is related to volatility and the stage of the business cycle. For the former we use realized volatility or the VIX depending on the period, and for an indicator of the latter we use the lagged unemployment rate. Volumes rise when the VIX rises and volumes fall when unemployment is high. Over the last 15 years, the cyclical component of volumes is particularly well explained by the VIX and unemployment lagged two years, with a fit of 77%. This fitted relationship indicates that trading volumes are currently where history predicts they should be. So the fall off in volumes is in line with where we are in the macroeconomic recovery and does not suggest a structural break either.
