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28 January 2013

The Outlook for the US Equities Industry

TABB Group is modestly bullish on the industry in 2013 and believes revenues and volumes will climb slightly this year. But institutional equity traders are likely to remain on the sidelines until market correlations drop.

Each year our US equity clients ask us to provide market projections on areas that impact their business -- primarily, market volumes, commission rates, electronic trading usage, and high-frequency trading numbers. Firms want to know if we are bullish or bearish on the industry. In an effort to distill the factors that we look at when making our projections into an easy-to-read number, we created an index: The US Equity Brokerage Index, which has 10 underlying components representing a near-term outlook on the industry. We calculate it on a monthly basis.

One of the most interesting trends revealed in the chart below is the unprecedented disparity between the S&P500 and the TABB index since mid-2010. This demonstrates that transactional revenues and market performance have not moved in tandem for several years. But we believe that the divergence will not last. Either the S&P is bound for a correction, or it is time to go long US equity brokerage. The truth is somewhere in the middle: We are modestly bullish on the industry and believe revenues and volumes will climb slightly this year.

TABB US Equity Brokerage Index

Source: TABB Group

From an investor’s standpoint, it is hard to complain about the performance of the market in 2012. But despite the incredible decline in volatility since September 2011, correlations remain relatively high, particularly compared to the kind of relationship the VIX and ICX experienced prior to 2008. TABB Group believes that, until the market exhibits less correlation, we will not see a tremendous increase in active institutional equity trading activity.

In June 2012, the equity futures market surpassed the cash equity market. At the time, TABB Group speculated that if the trend were to continue, it would be a bad sign for the equities brokerage business, as it is another indicator of passive investing. However, equity futures volume market share has steadily declined since then.

Meanwhile, we expect that portfolio managers will take bigger bets on fewer names. Activity around Herbalife and Dell are good examples of the kind of trading opportunities we expect to see this year.

[Related: "The Pyramid Scheme of Volume"]

Another impact on volumes is the outcome of the continuing investigation of insider trading. If any marquee hedge fund managers were to be indicted, volumes would suffer. But while we expect there will be some hefty fines levied, we don’t anticipate any arrests. News and regulatory battlegrounds will dominate hedge fund performance and the nature of the hedge fund business.

Investors are still on the sidelines, but client balances at the major discount brokerage firms have been steadily ticking up along with strong market performance. One of our likely scenarios is that investors begin to put money back into the market, quantitative easing itself begins to ease, interest rates move up, and stock market correlations unwind. The combination of all of these factors would result in a near-term increase in transactional volumes without the long-term negativity of a bear market. Our fingers are crossed along with yours.  

The full TABB Group report, “US Equities Market: 2013 State of the Industry,” brings together our most requested data points in one concise report. It includes US equity institutional revenue cut three ways (Total, Execution Only and Low-Touch), market participant volumes, execution venue market share, high-frequency trading revenue, mutual fund flows, leveraged US equity volumes and more.

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