Investors had little trouble finding liquidity as trading exploded at the beginning of August, amid a wave of volatility that hadn’t been seen since the financial crisis.
William Quinn, senior equity trader at HighMark Capital Management in San Francisco, said things were orderly despite broad news reports of market tumult.
"We found adequate liquidity in executing orders," Quinn said. "We exercised patience throughout the week and found liquidity to be there when we needed it."
The market’s massive price swings began during the first week in August, when the Dow Jones Industrial Average dropped 5.75 percent. It continued the next week, with the Dow plummeting 635 points on Aug. 8, then rebounding 430 points on Aug. 9, falling another 520 points Aug. 10, and recovering 413 points the next day. The Dow ended the week down only 197 points from the previous Friday.
As the roller coaster ride began, many believed the catalyst for a doubling in trading volume was S&P’s downgrading the U.S. government’s credit rating. However, the activity had its roots in a confluence of circumstances.
Traders had to contend with trouble in Europe’s banking system and concerns over the finances of several countries. In fact, during the week leading up to the downgrade, investors pulled out 0.3%-or $18 billion-of the more than $6 trillion in equity funds.
Yet trading continued throughout the turmoil, as portfolio managers adjusted their investment strategies.
Nearly 18 billion shares changed hands on Aug. 8, according to BATS Trading. That’s compared to 8.5 billion shares traded on the first day of that month. Earlier this year, volumes averaged about 7.5 billion shares a day.
Bloomberg reported an unprecedented number of quotes, even on days when volume was off slightly, an indication of unfilled orders and the likely presence of high-frequency traders.
According to Vipul Nagrath, Bloomberg’s global head of research and development, the firm had never seen such a high level of quotes in the market. Quote activity, or ticks, went about 35 percent higher than anything seen up to that point-including the "flash crash" of May 6, 2010.
"The tick volume is up dramatically, when the actual volume of shares traded isn’t at the highest levels," Nagrath said.
Aug. 10 set an all-time high of 43.7 billion ticks. That was about one and a half times the number of ticks recorded during last year’s flash crash.
Nagrath said HFTs were the likely culprit for the increase in ticks. He pointed out that while overall volumes were high on Aug. 10, they were actually down somewhat from the previous day. "I believe that some of it is probably due to HFTs," Nagrath said. "The algorithms are out there, putting these bids and offers out, not getting a fill on the other side, and then canceling it."
No 2008 Redux
Throughout all the drama at the beginning of August, equity market liquidity remained excellent from a buysider’s perspective. So much so, that pros reported multiple million-share prints during the peak trading days in August.
Though the market had some steep drops, the situation differed dramatically from last year’s flash crash, when a flood of sells and a near absence of buys forced the market downward.
Dennis Fox, head trader at Munder Capital Management, said it was business as usual at his firm. But portfolio managers eyed opportunities amid beaten down stocks. "We’ve been feeding out some sell orders into the strength and getting taken," he said.
Despite selling pressures, Armstrong Shaw Associates added to holdings and didn’t buy into the media hype, said Craig Jensen, principal and head of trading at the New Canaan, Conn. firm.
"We were not participants in the selling," Jensen said. "When things are as irrational as they were, we tend to take a step back. With that said, we are long-term investors, so while we will not be the first ones in the market to buy, we look for opportunities to add to positions as things continue to move down."
As rough a ride as it was, Jensen said things never got as bad as they did in 2008 during the financial crisis. The situation this time around, while nerve-racking, was much more quantifiable and offered tangible limits.
"While it can be nauseating, volatility creates opportunity and helps to form bottoms," Jensen said.
Blocks Trade
The increased trading and liquidity has also given rise to more block and program trading. Dan Royal, co-head of global trading at Denver-based Janus Capital Group, told Traders Magazine that program trading continued unabated with little change in conviction on the part of portfolio managers.
Alfred Eskandar, head of U.S. equities at block trading venue Liquidnet, said the crossing network shared in the activity. Its volume at the beginning of August was the highest it had been since November 2008.
Liquidnet’s block trade size was also up, rising to 50,000 shares in August. "Certainly the appetite for quantity discovery has not dissipated," Eskandar said.
He noted institutions picked up their trading levels before the rest of the market and "well ahead" of the volume uptick following the U.S. credit downgrade. Eskandar interpreted this to mean it was more than just the downgrade that triggered activity.
"The European debt crisis has been in the news for quite some time," Eskandar said. Worries in Europe were a more likely culprit for heightened market activity than anything else, he added.
High-frequency traders remained active throughout the up-and-down days of August. Manoj Narang, founder and chief executive officer of Tradeworx, a Red Bank, N.J. HFT, said his firm profited from the uptick in market activity.
"Volumes and volatility are both massively elevated-meaning that the demand for liquidity by long-term investors is high," he said. "When the demand for a commodity is high, be it crude oil or liquidity, the profits for suppliers of the commodity tend to be high as well."
Last month also saw investors flock to exchange traded funds. Whenever there is a major stress in the system, correlation in the marketplace tends to increase, and with stocks moving together, investors are particularly drawn to ETFs, said Rob Karofsky, global head of equity trading for AllianceBernstein.
Historically, ETFs make up 30 to 35 percent of daily volume, but recently that has increased to about 40 to 50 percent, Karofsky said. Investors want to take bets on the entire market, not just on individual stocks.
What is more, investors are looking beyond large-cap ETFs like SPDRs and putting money in funds that include small caps.
Mark Travis, president and portfolio manager of the mutual fund firm Intrepid Capital Funds, which specializes in small-cap stocks as well as high-yield debt, said liquidity has been less of a problem for small caps than it has been in the bond market.
Still, small-cap investors have to be patient, he said. His firm invests in companies with market caps as low as $100 million, so it can be difficult to deploy large amounts of money to them.
And deploying his fund’s money is just what Travis wants to do. He said valuations are attractive, though he is mindful to leave some cash on the sidelines for redemptions by skittish investors.
"In a perfect world, I would be consuming my cash with attractive investments, not with requests for redemptions," Travis said.
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