March 21, 2012

Clouds and Wind Without Rain

We’re in glorious Cincinnati where the land is rushing headlong into spring. Even a photo snapped in haste northward at night from Covington at the John Roebling Bridge seems cast in ethereal light.

Speaking of rushing headlong, if you’re here in the heartland, join us at the noon NIRI Tri-State chapter meeting today. We’ll talk about what’s got markets hasting.

There’s a saying from the bible: “Like clouds and wind without rain is a man who boasts of a gift he does not give.”

It made me think of volume. Enough of you have written asking about what may underlie declines in market volume that it deserves a community answer. We hope ours will do.

In 1980, Wilshire Associates was tracking about 3,500 publicly traded companies in its index that would become the Wilshire 5000, the category-leading total-market index. The Dow Jones Industrial Average closed that year at 963. Average daily trading volume was 45 million shares on the NYSE.

By 1990, the Wilshire 5000 had over 5,000 companies as IPOs outpaced consolidation. Average daily volume across the NYSE, Nasdaq and American Stock Exchange was 302 million shares, and the Dow Jones Index closed at 2,633.

In 2000, total companies had slipped from the 1998 zenith of 7,460. But daily volume had mushroomed to 2.8 billion shares. The Dow concluded Y2K at 10,786.

Volume built to helium-laughter level of about 7 billion shares daily in 2009. But in 2012 so far, markets are averaging 3.6 billion shares daily. The Dow is up. But the number of public companies is down. Way down. Care to guess how many make up the Wilshire 5000 in 2012?

Focusing on volume, why has it been chop-blocked? Many reasons. Falling volatility. Multi-asset-class trading cannibalizing equity volumes. Money moving to global markets. Fewer prime brokers supporting trading. Tougher rules, fewer trading firms. Fewer brokers. HFT facing regulatory heat.

All are true. But volume is clouds and wind without rain. It exploded because regulators decreed best price the definition of “good competition,” and a system of incentivizing best price built to a fever pitch on shill bids and a grandiose system of filling and digging ditches.

That’s artificial. As substance evaporates from markets, firms will stop competing on price. And volume will decline.

There are 3,675 public companies in the Wilshire 5000. About where were in 1980 when volume on the NYSE was 44 million shares daily.

Sure, there are big, big companies now. Indexes, ETFs, structured products, complex trades with options and futures – and VIX volatility futures and options, which have exploded in popularity, expire today.

But that’s clouds and wind without rain. Volume is a braggadocios giver. It cannot manufacture substance.

So maybe less volume is better.

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