The equities market isn’t going to get any help from investors leaving the bond market any time soon.
That’s the finding in a new report from Greenwich Associates. The Stamford, Conn-based consultancy wrote in its latest report, “U.S. Equities: Five Reasons Why the Great Rotation Might Not Be So Great,” that the institutional shift out of domestic equities will continue and keep pressure on trading volumes, despite the expected rotation out of fixed-income products and into equities as interest rates are expected to rise.
As interest rates rise, fixed-income products see their values erode whereas equities don’t lose their value as interest rates rise. Interest rates are expected to rise either later this year or next as the Federal Reserve curtails or “tapers” its current bond purchasing program designed to stimulate the U.S. economy via low interest rates.
At about 6.3 billion shares, Q1 2013 daily trading volume in U.S. equities is down by a third from the 2009 market high of roughly 9.3 billion. It is not expected to bounce back much in 2013, Jay Bennett, consultant at Greenwich told Traders Magazine.
“The buyside said in our interviews they don’t expect volume to bounce back this year,” Bennett said. “Most are skeptical or optimistic this shift to equities from fixed-income will happen.”
Bennett added he was surprised at this outcome given the pressure on the buyside to generate alpha and returns. He added the sellside will be forced to scale back its operations further as the buyside will inevitably trade less.
“Recently, brokers have started planning for a new market normal in which trading volumes, commission payments and brokerage revenues hover close to today’s depressed levels,” the report noted. “Brokers are now in a reset period in which they are scaling back their business structures to align with a U.S. equity market of about $9 billion-$10 billion in annual institutional commissions, as opposed to the $13.9 billion peak reached in 2009.”
Eighty-one percent of the buy-side institutions participating in Greenwich Associates’s 2013 U.S. Equity Investors Study said U.S. equity market turnover will fail to rebound to pre-crisis levels by 2014. Bennett said part of the reason behind this was the fact the average stock price has risen from around $30 per share to around $60 a share. Given this increase in average stock price, there has been no recovery in trading activity, despite net inflows to U.S. equity portfolios among the institutions taking part in the study. What’s worse, Greenwich noted, is that this drop in equity trading has occurred despite – stock market -indexes – hovering near historic highs and low volatility.
“Volatility levels aren’t anywhere near the levels they were back in crisis and this has hurt volume,” Bennett said. “In a perverse sense, volatility is the friend of the brokers. But with volatility low, the buyside isn’t moving in and out of positions.”
Greenwich also reported that most U.S. institutional funds, as a group, have embarked on a multi-year effort to reduce their exposure to domestic equities. Among all U.S. pension funds, endowments and foundations, average allocations to domestic equities have declined from 45 percent of total assets in 2001 to just 27 percent in 2012. Nearly one-quarter of the institutional funds participating in the most recent Greenwich Associates U.S. Investment Management Study say they plan to further reduce domestic equity allocations in the next three years.
Greenwich Associates data shows that although assets will likely shift out of bonds as interest rates start to rise, the flow of institutional assets into U.S. equities will be moderated by the buysides’ own investment strategies.
“Because institutions are focused on diversifying portfolios with new investments in international assets, private equity and other alternative asset classes, the impact of the Great Rotation on the domestic equities business might be smaller than otherwise expected,” Bennett said..
The report, conducted between December 2012 and February 2013, surveyed 217 U.S. equity fund managers and 294 U.S. equity traders at buyside institutions.
