NEW YORK (Reuters) - The U.S. stock-market surge in January may feel to some like having reached a remote mountain peak. It was a lot of work, but there are not many people to celebrate with.
The S&P 500 .SPX rose 4.4 percent in January, the second-best month for stocks since 2010. But trading volumes were down sharply - speaking to worries that the market’s gains are unsustainable.
Rather than a cause for concern, however, strategists say the reduced volume may be better down the road for individual investors frustrated in recent years with the fluctuations caused in part by volatile, computer-driven activity.
January, in contrast to wild daily moves during the summer of 2011, was relatively quiet. That kept high-frequency traders and hedge funds that capitalize on big shifts on the sidelines.
If the low-volatility environment persists, it could eventually bring in institutional investors who have largely sat on their hands in recent months, and help move stocks higher.
That hasn’t happened yet and the general public has also stayed on the sidelines. Data from the Investment Company Institute showed net outflows of more than $7 billion in the first three reporting weeks of the year from funds that invest in U.S. equities, while $16.7 billion flowed into bond funds.
Volume in exchange-traded funds was down considerably as well, irrespective of the asset class the ETF tracks, according to JPMorgan data. Trading volumes of ETFs in January that track equities, bonds and commodities were down on average 36 percent compared to the average daily volume in the second half of 2011.
“Given that macro hedge funds are frequent users of ETFs, this supports our conclusion that hedge funds have not participated in the rally we have seen to start the year,” said Nikolaos Panigirtzoglou, European head of global asset allocation and alternative investments at JPMorgan.
Daily volume on the NYSE, Amex and Nasdaq dropped to 6.93 billion shares in January, a 15 percent decline from last January, and way off a peak of 9.42 billion in January 2009.
After its largest quarterly percentage spike on record, a 160 percent hike in the third quarter of last year, the CBOE volatility index .VIX fell almost 50 percent in the last quarter and slipped almost 17 percent in January alone to close below the 20 level for the first month since June.
Day traders, and more importantly, high frequency traders rely on large daily fluctuations to maximize their profits.
“A rapid decline in volatility is going to drive shorter trading strategies out of the market,” said Adam Sussman, senior analyst specializing in market structure at TABB Group in New York.
According to TABB Group, high frequency trading - mostly a short-term strategy - accounts for about 55 percent of market volume. There’s a discrepancy in the percentage and it can go up to 70 percent, since the definition of HFT is not yet clear.
Sussman said as the market draws its focus away from macro economic and headline-driven events and focuses more on company fundamentals, the market will slowly shift to favor stock pickers.
“As correlations unwind and volatility subsides ... we’re going to see an overall decrease in volume, but in the long run that is better for the market,” Sussman said.
He described it as a cycle after which the longer term investors are among the few left and a period of calm entices more big money. Low volatility takes some of the risk reward off the table and drives away traders.
“Our volume is down somewhat,” said Don Bright, director and trader at Bright Trading in Chicago, a professional group that specializes in short-term trading. “But I think it’s cyclical.”
“We need to have a little bit more movement for us to risk our money.”
To be sure, the lack of volume still worries traditionalists who see trading activity as central to sustainable gains in stocks. The S&P 500 recently reached a six-month high.
“Unless volume kicks in and starts to increase, that does not bode well for the continuation of the rally,” said Steven Wolf, managing director of investments at Source Capital Group in Westport, Connecticut.
“If volume continues to contract we may have reached an interim top.”
Reporting by Rodrigo Campos; additional reporting by Gertrude Chavez and Jonathan Spicer; editing by David Gaffen; Diane Craft