Volatile moves in the equity and fixed-income markets have analysts wondering whether this month’s trading will lead to profits or pain for Wall Street’s biggest banks.
Volume and volatility may help third-quarter results in a seasonally weak period, Barclays analysts led by Roger Freeman said in a note this week, cautioning that bank trading positions will determine the overall result. Glenn Schorr, a Nomura Holdings Inc. analyst, wrote that the sell-off is likely to cause “market-making pain” and lower investors’ risk appetites.
The five largest U.S. investment banks have reported trading revenue for the first six months of 2011 that fell 13 percent from a year earlier. The firms are trying to turn around trading results as the Dow Jones Industrial Average posted more than 400-point moves for four straight days, the first time that’s ever occurred.
“It’s awfully hard to know how firms have positioned themselves throughout this and what impact that will have,” said Matthew Burnell, an analyst at Wells Fargo & Co. (WFC) “Equities trading, just by the nature of the business, tends to have less positioning risk, whereas fixed-income trading tends to have more.”
The Standard & Poor’s 500 Index rebounded yesterday after plunging 17 percent from July 22 through Aug. 10 amid Europe’s debt crisis and a political battle over the U.S. debt ceiling that prompted S&P to cut the country’s credit rating. Both European shares and the Russell 2000 Index of small American companies entered a bear market this week, falling at least 20 percent from their previous highs.
Moves in equity and Treasury markets raised questions about trading results at the five largest U.S. investment banks -- Goldman Sachs Group Inc. (GS), JPMorgan Chase & Co., Bank of America Corp. (BAC), Citigroup Inc., and Morgan Stanley. The firms posted their fifth-straight year-over-year quarterly decline in the second quarter, and July was “unseasonably slow,” Freeman said in an Aug. 8 note. Spokesmen for the banks declined to comment.
Trading equities and fixed-income products accounted for 23 percent of total revenue at the five banks last year, ranging from 56 percent at Goldman Sachs Group Inc. to 16 percent at Charlotte, North Carolina-based Bank of America, filings show.
The firms are likely to benefit from higher equity volumes. Average daily volume on major U.S. exchanges has climbed to about 9 billion shares so far this quarter, Bloomberg data show. That compares with 7.14 billion in the second quarter and 7.66 billion in the third quarter of 2010.
The volume has brought increased volatility. The S&P 500 has moved in an average range of 2.65 percentage points between intraday highs and lows in the past month, the biggest gyrations since the 20-minute “flash crash” on May 6, 2010, erased $862 billion from the value of U.S. shares before prices rebounded.
That pushed the Chicago Board Options Exchange Volatility Index, or VIX, up 50 percent to 48 on Aug. 8, the biggest surge since February 2007, then down 27 percent the next day for the second-largest drop in its 21-year history.
Debt volume levels often don’t accurately indicate fixed- income trading revenue, Schorr wrote in an Aug. 10 note. The two most predictive factors in Schorr’s analysis were the volume of debt underwriting and the 10-year U.S. Treasury rate.
The 10-year rate dropped to 2.34 percent yesterday from 3.16 percent at the end of June and 2.68 percent a year earlier, and fell as low as 2.03 percent on Aug. 9. Companies have issued $147.7 billion in U.S. bonds this quarter, down from $243 billion in the same period of 2010. Both trends may point to a drop in fixed-income revenue, Schorr wrote.
The extra yield investors demand to own company bonds worldwide instead of similar-maturity government debt increased to 2.10 percentage points yesterday, the highest level since October 2009, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. Prices have fallen 5.5 percent this month for bonds in the Bank of America Merrill Lynch High Yield Master II index.
Banks may benefit from the market fluctuations depending on the success of their principal bets and whether clients continue to stay active in the markets or pull back.
Goldman Sachs said a bet against equity volatility led to losses in the second quarter of 2010, when the VIX rose after the May 6 crash. Morgan Stanley (MS) lost at least tens of millions of dollars last quarter on a wager on inflation expectations, three people familiar with the matter said at the time.
Some banks eased risk-taking in the second quarter amid political and economic fears. Goldman Sachs cut its value-at- risk, or VaR, the maximum amount the company estimates it could lose from trading on 95 percent of days, to $101 million. The figure was the lowest since the third quarter of 2006.
“We saw firms taking down positioning risk in the second quarter, and we haven’t seen anything since then that would argue that trading shops are putting on more risk,” Burnell said. “Particularly given the volatility we’ve seen, I would expect that it would be difficult to ask risk managers to allow most trading desks to take on materially higher levels of risk.”
Some analysts agree that the turmoil has been a positive for U.S. exchanges. While those companies have been expanding to include derivatives and technology services, trading fuels revenue from transaction fees.
U.S. options volume has increased 73 percent in August from the year-to-date average to 28.5 million contracts a day, according to a note yesterday from Goldman Sachs analysts led by Richard Ramsden.
Outlook for Exchanges
Goldman Sachs placed Knight Capital Group Inc. (KCG) and Nasdaq OMX Group Inc. (NDAQ), the second-biggest operator of U.S. stock exchanges, on its “conviction” buy list, and upgraded IntercontinentalExchange Inc. (ICE) to “buy” from “neutral.” Chris Kotowski, an Oppenheimer & Co. analyst, reiterated his “outperform” rating on CBOE Holdings Inc. (CBOE) because it is likely to benefit from the recent volatility.
“Our exchange names have seen a positive impact on third- quarter earnings from the recent instability in the market,” Freeman wrote in an Aug. 10 note. “While clearly we do not expect volumes to run at recent levels through the remainder of the quarter, we do believe that the recent volatility and subsequent uptick in volumes provide a boost to what is normally a seasonally weak quarter of the year for the exchanges.”
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