Stock-Trade Winds Don't Blow Wall Street's Way

The Wall Street Journal

"A perfect storm" is what sailors call a disastrous concurrence of perilous weather events. Wall Street, by contrast, has experienced in the second quarter what might be better described as "a perfect calm."

Banks often get a revenue boost from jittery investors shifting portfolios in more volatile times. Trading desks benefit from both higher volume and wider spreads—or the difference between what one investor will sell for and what another will pay—that tend to accompany price swings, as long as they aren't too sudden or abrupt.

Earlier this year, the dramatic decline of volatility and volume that drained revenue from Wall Street's fixed-income, currency and commodities trading operations was somewhat offset by growth in equity sales and trading. This quarter, dread tranquility has struck equities as well.

Average daily trading volume in S&P 500 stocks since April 1, for example, is 29% below its five-year average and 17% below the first quarter. The Chicago Board Options Exchange Volatility Index, or VIX, which tracks investor expectations of price swings, fell to a six-year low in early June. While this volatility gauge ticked up Thursday on the back of Iraq-related fears, it is still 40% below its 10-year average.

The situation is made worse by the Volcker rule, which bans banks from engaging in most speculative trading. As a result, proprietary trading revenue no longer serves as counterweight to dips in market-making.

Fortunately, these effects aren't quite as extreme in equities trading as they are in the fixed-income arena. So while the second quarter might see equities revenue fall at the biggest banks, the declines aren't likely to rival those in fixed income. Investors are bracing for double-digit declines in that business at many banks in the second quarter compared with a year earlier.

And equities-trading revenue isn't an awfully big slice of the overall pie at J.P. Morgan Chase, Bank of America or Citigroup. In 2013, it generated around 5% of revenue for J.P. Morgan and BofA, and about 4% at Citi. All three tend to see equities-trading revenue move in lock step, reflecting their dependence on client flows and trading volume.

Still, falling fixed-income revenue is more painful if equities aren't able to take up as much of the slack. That could land a one-two punch to results, especially as mortgage revenue continues to be lackluster and a reversal in long-term bond yields this year could again bring net-interest margins under pressure.

A decline in equities would hit harder at Morgan Stanley and Goldman Sachs. They generated about 20% and 21%, respectively of 2013 revenue from equities sales and trading. What's more, Goldman and Morgan are particularly exposed to a fall in volatility because they generate much less of their equities revenue from financing customer portfolios. That means they are more dependent on actual transactions and price swings.

Another issue may come into play this quarter: Four of the five big banks shrank their equities-trading portfolios last quarter. That followed a run-up in holdings as many anticipated equity market volatility. This was part and parcel of a view that 2014 would see renewed trading vigor as long-term bond yields continued to march higher and economic activity grew stronger. But things so far haven't worked out that way.

The trading that resulted from such shrinkage likely boosted equities revenue at BofA, Citigroup, Goldman and Morgan Stanley. But unless they are willing to take down their trading inventories even further this quarter—which would signal they think difficult trading conditions will continue—the banks won't likely see a similar boost.

The exception is J.P. Morgan, which held just about the same size equities-trading portfolio at the end of the first quarter as at the year's start. That may have given it room to sell holdings this quarter—which could help revenue.

No matter how banks try to row against the market tide, though, there is going to be less wind in their trading sails.

Write to John Carney at john.carney@wsj.com



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