Beware the dead zone in August, as ETFs become much harder to trade efficiently.
If you need further proof that the world is still macro-driven—a fundamental precept Matt Hougan was spouting off about yesterday on CNBC—then let’s engage in a little exercise.
Unless you’ve been in a cave—which is entirely possible, bear with me—then you probably saw that trading volumes just hit the year low. If you missed that little news bite, it’s probably because you have indeed been in a cave, along with a large cadre of investors.
There’s nothing tremendously surprising about this—it’s August, it’s been hot and the “wait and see what the Fed does” disease has latched on pretty hard to a big chunk of the market.
But a priori, how would you expect low volumes to impact ETF investors? To answer that, you have to make some assumptions about what kind of investors have been spending time in the proverbial cave.
Conventional wisdom—for as long as I’ve been in the markets, which dates back to the crash of ’87—is that volume variability is driven primarily by speculation.
The theory goes that there’s a base level of transaction activity driven by long-term strategies that will occur regardless of market conditions.
Your payroll deduction hits; you mechanically buy some mutual fund shares; that mutual fund mechanically buys some stocks. Or, if you’re a retiree, you have a long-term divestment plan going on, mechanically selling a bit each month. Endowments have cash to reinvest, sovereign wealth funds have scheduled rebalance activity, and so on.
So when volumes dip, the money that’s not in the market on those sleeper days are folks chasing earnings reports, betting on volatility spikes, swinging for the fences in small-caps. That doesn’t necessarily pigeonhole the sleepers as hedge funds and prop-desks.
After all, Matt Hougan has been known to take an ill-conceived flier in his less-than-hedge-fund-sized Schwab account from time to time. So let’s just call the missing dollars “hot money” and not fret too much about whether it’s from Berkeley, Calif. wage slaves or Darien, Conn. Ferrari leasers.
With that mental picture in mind, what do you think happens to ETF investors? Let’s cut to the tape:
The gray background is consolidated tape volume. Note that this doesn’t suggest yesterday was the lowest day of the year.
Commonly quoted stats are the volume on NYSE. But a tremendous amount of volume trades off NYSE, so in our analysis, we generally always look at the complete, consolidated tape, which includes not only NYSE and Nasdaq volume, but OTC and bulletin board trading, and all of the fragmented exchanges like BATS so beloved by high-frequency traders.
The top red line is the percent of that total volume—in dollars—represented by ETF trades. The bottom blue line is the percent on share count. Since the median ETF handle is much higher than the median stock price handle, share volume isn’t very representative, so we tend to focus on the red line.
So what does this chart tell us?