Eric Burroughs's Profile
What market volumes and vols are saying
For what has been a fairly tumultuous month across markets, many equity indexes have seen volumes only whither as the month of May has worn on. Away from the speculative maelstrom in commodities, only U.S. Treasuries have seen decent volumes this month when compared with one-month averages. The lack of volume in these moves, and the sideways action in many equity markets, suggests that many investors are happy to sit on the sidelines until some of the noise settles down and signals start to emerge. What kind of noise? Think of the litany of reasons blamed for market moves this month: fears of a U.S. and/or global slowdown, fears of a China slowdown on TOP of fears of more China tightening, fears of Greek debt restructuring in the latest wave of the euro zone crisis (what European bank hasn’t had time to hedge Greek credit exposure by now?), Asia central bank tightening, etc. At the end of the day, none of them is all that compelling. What we’ve seen is a shakeout in some frothy markets, mainly commodities, that has prompted a broad wave of risk reduction across assets. But looking at volumes, this is no rush for the exits — just a natural paring of positions. It does suggest that we could be in for a choppy summer as market players grapple with the end of QE2, the U.S. debt ceiling debate and fuzzier economic data. At the same time, many gauges of implied volatility are also subdued. The moves in equities show signs of markets being in balance. On the flipside, the rush into Treasuries as yields have fallen point to a market that may be getting ahead of itself, just as implied volatility on T-note futures suggests complacency. So watch Treasuries closely in coming weeks – either an acceleration of the trend, or a sudden reversal, may be the key gauge on how to think about the risk trade.
Starting with the U.S. stock market, volume has only eroded — both during the market runup to three-year highs this month and the subsequent turn down on the commodities rout and some mixed signs on the economy. Looking at New York composite volume (NYSE total), the biggest volume day of late was on May 4 — two days after the market peaked and turned, and showing some nervousness. Still, it’s hard to conclude that there is much axiety out there. I like to look at volumes in the context of a 20-day (one-month) moving average, so relative to the near-term trend. Spikes through that rolling average signal stronger conviction, whatever the market direction. The simple fact is that we have not seen very strong volumes, and in fact the 20-day average itself is at the lowest levels coming out of the crisis. That suggests a lot of market players are simply unwilling to step in at this stage: so not too worried about a selloff, but not wanting to chase the market higher here. Thus a fairly balanced market, and so the VIX and S&P implied vol flatline.
Here in Hong Kong, we have also seen pretty weak turnover on the HKEx main board thanks to the painful range in place for more than a year now. Even some signs of a technical breakdown failed to materialize, and the Hang Seng is stuck in a rough 22,000 to 25,000 range in place since the May 2010 Flash Crash. The picture is more complicated in Hong Kong thanks to the array of new IPOs hitting the market over the past year, including AgBank and lately Glencore. That has tended to both drive up turnover AND keep a lid on the market, given the money being sucked into the new shares from existing holdings. Still, over the past year the clear signs of surging volumes have come when the market has reached highs in this broad range, such as October last year and April this year. It’s a similar picture in Shanghai. Another clear sign that investors are more eager to chase the market higher rather than lower, and thus are not particularly nervous.
Then there’s the poster child of Asia’s equity bubbliness: the Jakarta Composite. Even during the market woes of May, the IDX has pushed to record highs. Not just that, but the biggest volume days have come when the market has risen, not fallen. Earlier in the year, Indonesia was the case of a strong Asian economy being behind the curve in responding to inflation and being duly punished by foreign investors, who quickly dumped both stocks and local bonds (nevermind that inflation quickly peaked and the central bank was vindicated). Yet even during the January bout of selling in Indonesian shares, volume in Jakarta was pretty weak. Only recently has it picked up with the market’s rise. So again, conviction lies with the buyers in this market environment, not the sellers.
So clearly the U.S. bond market is right and the equity market is wrong, right? Well I’m not so sure. Volume in Treasuries has clearly increased this month. As usual, it’s a mix of factors: trading around quarterly refunding auctions, an unwind of inflation trades in the commodities selloff (long TIPs vs nominals), a decent short-squeeze and of course the array of weaker U.S. economic indicators. The softer data can likely be explained by this year’s wicked weather and the Japanese supply chain disruptions — especially in light of the strong April jobs report. Only PIMCO’s Bill Gross seems “technically” short at this point in decrying the lack of risk premium built into yields (even if it always seemed more a duration hedge for the Total Return Fund than anything). There are other bigger picture factors at play in Treasury yields: banks are still repairing their balance sheets while preparing for Basel III. Japanese banks and institutional investors are still solid buyers. Some prominent fixed-income analysts are now targeting a 10-year yield of 2.75 percent to 3.0 percent compared with the current 3.07 percent. But as traders have said, Gross has a point on the lack of risk premium. That leaves the market somewhat exposed with QE2 down to its last few weeks.
The small daily moves in Treasuries have driven down the realized volatility in the market, taking one-month implied vol with it. At this point, Treasuries are preparing for further economic weakness and the Fed to be on hold for many, many months, with the first half of 2012 eyed for a first hike. Treasuries is the one market where volumes suggest investors are chasing the trend, leaving it ripe for a sharp reversal if anything — say another solid payrolls report — delivers an expected jolt. Implied vols just go to show that Treasuries are not expecting the unexpected, rightly or wrongly.