Feb. 19 (Bloomberg) -- The biggest surprise on Wall Street this year is proving to be the record $16.3 trillion of shares traded in the U.S. as stocks show no sign of rebounding from the first bear market since 2002 and the economy teeters on the brink of a recession.

Daily trading in December and January averaged 7.44 billion shares, 13 percent more than the previous quarterly peak, New York Stock Exchange data show. The pace is a boon to Goldman Sachs Group Inc., Morgan Stanley, Merrill Lynch & Co., Lehman Brothers Holdings Inc. and Bear Stearns Cos., whose equity- trading revenue will slip just 6.1 percent in 2008 from last year's record $36.7 billion, according to Sanford Bernstein & Co. The same income-stream shrank almost 40 percent in 2001 and 2002, after the Internet bubble burst.

Hedge fund customers who thrive on market swings will buttress the results while the brokerages' increasing use of electronic systems rather than human traders will keep costs down, exchange officials and bank executives say. The growth in equity derivatives and the firms' international expansion may also sustain revenue in a way not seen in prior market declines. For the biggest U.S. securities firms, stock trading may cushion the blow of subprime writedowns and credit losses.

``The equities business is much more diversified than it was eight years ago by a long shot, and it's more profitable because you are able to do so much more in an electronic world,'' said Daniel Coleman, 47, co-head of global equities at Zurich-based UBS AG, Europe's largest bank by assets. ``We've just created a lot more operational leverage.''

Recession-Bound

The International Monetary Fund cut its 2008 growth forecast for the world's biggest economies last month to 1.8 percent, the slowest pace since 2002, citing the surge in loan defaults in the U.S. Confidence among American consumers slumped to the lowest level since 1992 and factory output failed to increase, indicating damage from the housing-market contraction is pushing the economy toward a recession, according to figures released last week.

So far, the slowdown hasn't eroded the business of buying and selling stocks. The value of shares traded in the U.S. last month was 1.1 percent greater than the previous record, reached in July 2007, data from six U.S. exchanges show.

Average daily trading on the London Stock Exchange in December and January was 87 percent higher than a year earlier. Records were also set last month on German exchanges and NYSE Euronext's four European bourses, where 80 percent more trades were completed than a year earlier.

Historic Break

``Volumes in 2008, especially in the first half, are going to be very strong,'' said Andrew Fishman, 48, president of Schonfeld Group Holdings LLC, a New York-based brokerage that has doubled its trading over the past year to more than 200 million shares a day. ``While 2008 is more uncertain from a market direction or in terms of the overall economy, uncertainty tends to bring volatility and with that comes volume.''

The increase marks a break from history since trading has declined in all but one of the last six bear markets for U.S. stocks. Average daily volume at the NYSE fell as much as 27 percent in the year after the 1987 crash, according to Big Board data. About 21 percent fewer shares changed hands a year after the market peaked in 1980, while average daily trading after the January 1973 bear market didn't recover until January 1975.

A major difference now is the proliferation of hedge funds seeking to profit from swings in stock prices, according to Duncan Niederauer, who worked at Goldman for 22 years before being named chief executive officer of NYSE Euronext last year. Hedge fund assets have swelled to $1.87 trillion, almost four times more than in 2000, according to Chicago-based Hedge Fund Research Inc.

New Players

``I don't think the historical comparisons are valid because we have a completely different demographic of players today,'' Niederauer, 48, said in a Feb. 5 conference call with investors. Referring to the slowing economy, he said ``the effect is going to be very muted by the fact that a large part of the participants right now don't really care whether the market is going up or down.''

Hedge funds are private, largely unregulated pools of capital that use a wider range of trading strategies than most mutual funds, including betting on a decline in stock prices and using derivatives. In total, they account for about a quarter of trading in the U.S. and generate $3.2 billion in commissions, said Adam Sussman, director of research at Tabb Group LLC in Westborough, Massachusetts.

Greenwich Associates, a consulting firm in Greenwich, Connecticut, puts the total for 2007 at $2.5 billion, based on a survey of 250 institutional investors. That represents a 53 percent increase from 2005, Greenwich Associates data show.

Enter the Machines

Citadel Investment Group LLC -- Kenneth Griffin's Chicago- based hedge fund named to suggest a stronghold in volatile markets -- uses mathematical models and advanced computer systems to make investments that translate into about 5 percent of U.S. equity trading. D.E. Shaw & Co., which oversees $35 billion, relies on automated, 24-hour-a-day strategies that exploit shifts in asset prices around the world. The New York- based fund accounts for between 1 percent and 2 percent of trading at the NYSE.

Wall Street's biggest brokerages have kept pace by building machines capable of processing thousands of orders at a lower cost than hiring extra traders. Like the giant, shape-shifting robots featured last year in ``Transformers,'' the movie from executive producer Steven Spielberg, the electronic trading systems tackle a blizzard of tasks in fractions of a second.

Citigroup Inc.'s Automated Trading Desk tries to predict prices for 8,000 stocks 30 seconds into the future to give the largest U.S. bank an edge on rivals.

`Driving Down'

Credit Suisse Group, Switzerland's second-biggest bank, expanded its rapid-fire algorithmic trading programs to more than 30 countries and almost doubled its equity revenue over two years to 7.75 billion Swiss francs ($7.03 billion).

Lehman Brothers, the fourth-biggest U.S. securities firm by market value, climbed the ranks of brokers on exchanges in Frankfurt, Stockholm and Toronto after retooling its order- processing systems to reduce costs. The New York-based company was the top broker in Europe last year, up from third in 2005, and climbed 18 spots to No. 6 in Canada, according to Thomson Corp.'s Autex.

``There was zero work done in the 1990s around the cost of execution by broker-dealers,'' said Brian Fagen, 41, Lehman's U.S. head of electronic trading sales. ``We are now much more focused on that as there's a definite competitive advantage in driving down the cost structure.''

Minor Bruising

Equity trading in the first quarter will increase 28 percent from a year earlier at Lehman, and more than 15 percent at Morgan Stanley, according to a Feb. 15 report by David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia Waller in New York. He estimated gains of 11 percent at Bear Stearns, the fifth-largest securities firm, and about 6.6 percent for Goldman, the biggest firm. All four banks are based in New York.

For the year, ``they're not all going to post stellar numbers, but they're not going to get banged up,'' said Thomas Price, an 11-year Merrill Lynch veteran who is now a senior analyst at the Needham, Massachusetts-based consulting firm TowerGroup Inc. ``With the advent of technology and the expansion into global markets, I don't think they're going to let revenue slip that bad.''

Equity benchmark indexes from more than 45 countries, including Japan's Nikkei 225 Stock Average and France's CAC 40, have fallen more than 20 percent from their peak -- the common definition of a bear market. In the U.S., which accounts for at least 40 percent of revenue at the five firms, the Nasdaq Composite and the Russell 2000 indexes declined more than 20 percent from their highs. The Standard & Poor's 500 Index dropped as much as 16 percent from its Oct. 9 record.

Meaner, Leaner

``There will be less pain, but less pain still hurts,'' said Thomas Joyce, chief executive officer of Knight Capital Group Inc., which handles about $17 billion worth of trades daily. ``Brokerages may think they're mean, lean, fighting machines, but if a long bear market shows up they will certainly face challenges.''

Knight, based in Jersey City, New Jersey, makes markets in 17,000 U.S. stocks with 85 percent fewer traders than in 2002.

The stock slump in 2000 was the most severe bear market since 1971, according to the Stock Trader's Almanac. While volumes increased through the period, trading revenue at the five largest brokerages fell 16 percent in 2001 and another 27 percent in 2002, according to estimates from Sanford Bernstein analyst Brad Hintz in New York.

`More Transparency'

Brokers had fewer and smaller trading opportunities in 2000 as exchanges moved to quote stocks in penny increments instead of sixteenths of a dollar. Penny trading led to a drop in commissions as institutional investors turned to electronic systems to keep up with faster-moving quotes.

``You had more transparency of the execution process and those tools were on your own desktop,'' said Will Geyer, who was the head of U.S. trading in 2001 at Barclays Global Investors, when it managed more than $800 billion. ``At that point, the whole tide changed.''

By 2003, the average commission paid by an institutional investor trading NYSE-listed stocks had dropped to 4.7 cents per share from 5.9 cents in 2000, according to Greenwich Associates. Rates were about 4 cents a share in 2007, and they're unlikely to fall much further, Geyer said.

``The rate of commission compression is going to decrease,'' said Geyer, now president of JonesTrading Institutional Services LLC in Westlake Village, California. ``The rates have moved to such low levels now that there's not a lot left above the expenses.''

Risk Aversion

Stock valuations and further turmoil in the credit market may also attract investors to equities and bolster revenue. At the peak in October, companies in the S&P 500 fetched about 18 times their earnings for the prior 12 months, compared with 31 times profit in March of 2000, according to Bloomberg data.

``The market activity we experienced in 2007 will drive investors from complex products to more plain-vanilla products, and equities might be a beneficiary,'' said James Brett, 45, head of U.S. cash equities at JPMorgan Chase & Co. in New York. ``Times of extreme volatility tend to favor the stronger players, who have the technology and balance sheet.''

To contact the reporter on this story: Edgar Ortega in New York at ebarrales@bloomberg.net

Last Updated: February 18, 2008 19:08 EST