Wall Street trading is in deep trouble
Tighter regulations and the end of a lengthy bull market in bonds have changed the landscape forever.
The signs are everywhere on Wall Street. Trading floors that once buzzed with noise and energy are now as silent as cathedrals. Big firms that reaped huge profits from trading stocks, bonds, commodities and currencies are turning to staid money management to boost earnings.
What once was the main event is now just a sideshow.
There are many fewer traders now, and they're making much less money. And there are going to be even fewer very, very soon. With one big exception I'll discuss later, trading is dying.
And it's not just stock trading, where volumes are slightly more than half of what they were five years ago. Fixed income, currencies and commodities trading (FICC), Wall Street's huge profit driver of the 2000s, is in deep, deep trouble.
Bitter traders watching the gravy train leave the station blame regulators for tying Wall Street's hands or the Federal Reserve's unconventional monetary policy, which suppresses interest rate spreads and volatility that are traders' bread and butter. That's what's really behind former pit trader and CNBC commentator Rick Santelli's increasingly strident, desperate rants over the past few months.
And the so-called "debate" in the financial media about whether this decline is cyclical or permanent is completely phony. It's not coming back, guys, so maybe you should learn a useful trade like being a plumber or electrician. I'm serious.
Problem is, tighter regulation stemming from the 2010 Dodd-Frank Act, the Fed's zero interest rates and extraordinary bond-buying, and the end of a three-decade-long bull market in bonds have changed the landscape forever.
As of 2013, FICC trading on Wall Street plunged 23 percent from 2010, The Wall Street Journal reported. And although second-quarter trading revenues were not down as much as some firms had projected, they're still deteriorating. At Morgan Stanley (MS), which is leading the retreat from trading, FICC trading revenues have plummeted 60 percent from 2006, based on data in a study by Freeman Consulting.
"Essentially, the execution businesses are in deep trouble -- and fixed income is in the worst shape," said Brad Hintz, veteran analyst at Sanford Bernstein & Co., who is retiring to teach at New York University's Stern School of Business.
"ROEs (return on equity) in trading . . . have been cut in half," Hintz told me. And the cuts Wall Street firms have made so far don't "solve the fundamental problem. The trading businesses on their own are not beating their cost of capital."
In other words, Wall Street trading desks aren't pulling their weight. That will ultimately translate into even fewer bodies on trading floors.
Richard Stein, a partner in the executive search firm Caldwell Partners, sees this firsthand in his practice.
"Wall Street was sailing along for 16-17 years prior to 2007-2008 until the Titanic hit the iceberg," he told me. "These trading operations really were the main drivers of profits and leadership [at these firms]."
Several firms are scrambling to restructure and reorganize their businesses, he said, but it’s a losing battle. Trading's downward spiral is showing up in traders’ paychecks -- and in the pink slips that are sure to follow.
"If you're a trader on Wall Street, you're making two-thirds less than you used to, and the Sword of Damocles is hanging over you," Stein said.
Those with the biggest targets on their backs are the most highly paid. Managing directors (MDs) in trading who make $3 million to $5 million a year, Stein said, are "the most vulnerable." Hintz estimates that 40 percent of the compensation pool goes to MDs and above.
I don't feel sorry for them. Some of Wall Street's best traders already have jumped ship to hedge funds, which pay more and aren't burdened by as many regulations. And I suspect many of the rest have banked enough to get by in the lean years, of which there are going to be many ahead.
"This is Stage IV and there’s not much that can be done, because it’s irreversible," Stein told me.
"The world has permanently changed," Hintz said.
Unfortunately, while trading is dying on Wall Street, it's alive and well on Main Street. Average daily trading volume at E*Trade (ETFC), TD Ameritrade (AMTD) and Charles Schwab (SCHW) rose by an average of 18.9 percent in this year's first quarter over the last three months of 2013, The Journal reported.
And TD Ameritrade reported 492,000 trades a day in the first quarter, a 77 percent jump over the third quarter in 2007, when the bull market of the 2000s peaked. What are these people thinking?
Far from seeing Wall Street's trading slump as a disaster, I'm enjoying it immensely. I always found most trading to be, at best, a useless activity that just shuffles money around without adding any value. The environment that has been so bad for traders has been wonderful for ordinary investors, so for once, professionals' misery is our gain.
The big changes are hitting traders where it hurts. According to WeddingCrunchers.com, the term "trader" now appears only a third as often in New York Times wedding announcements as it did in 1998. Apparently, traders aren't such good catches anymore.
Whatever happened to the Masters of the Universe in Tom Wolfe's great 1987 novel "Bonfire of the Vanities" or the Big Swinging You-Know-Whats from Michael Lewis' "Liar's Poker"?
How the mighty have fallen! If trading was a stock, I'd short it.
--Howard R. Gold is a MarketWatch columnist and founder and editor of GoldenEgg Investing, which offers simple, low-cost, low-risk retirement investing plans. Follow him on Twitter @howardrgold.
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