The buy side aren't the only ones struggling to cash in on the explosive market volatility that has made this year one of the worst for markets since the Nixon era.
While hedge funds are on track to post their worst annualized returns since 2011, and traders are reeling from the worst weekly drop in US stocks since the crisis, Bloomberg has published a story claiming that the latest surge of volatility isn't just bad for investors - as Stanley Druckenmiller explained earlier this week - it's bad for the big banks, too.
And we thought volatility was supposed to be a good thing for brokers, because spikes in volatility are typically accompanied by a surge in trading volume, which means more money coming in for middle men who are earning a few bps off the spread. But the problem with this sell off is that, aside from a few periods where trading volume has surged, some of the biggest drops have occurred during relatively thin trading conditions. Put another way, the explosion of volatility has been so intense, that more traders are staying on the sidelines.
Though they have so far been a few isolated incidences, big blowups like the one that resulted in a $180 million loss made by Citigroup to an Asian fund, are proving incredibly costly. Another example: Natixis SA took a 260 million-euro ($298 million) hit this quarter from trades in equity derivatives.
Jamie Dimon waxed about the double-edged sword that is volatility during a recent public appearance.
"On trading, sometimes volatility is good; sometimes volatility is bad," Jamie Dimon, JPMorgan Chase & Co.’s chief executive officer, said at an investor conference this month. Recent gyrations were spurred by trade tensions, China selling U.S. Treasuries, the reversal of central-bank stimulus and political concerns relating to Brexit and Italy, Dimon said.
Bloomberg was quick to point out the irony in Wall Street decrying the shortage of volatility during the QE era - and its draining effect on profits - only to struggle when volatility finally returns.
BofA CEO Brian Moynihan recently ditched his optimistic outlook for Q4 profits, saying this week that he now expects trading revenue to drop by a few percentage points. That drop has already been priced into bank shares, with the KBW regional bank index down 27% from its highs (while an index of the biggest US banks is down 35%).
Banking analysts are split on whether the Q4 volatility will totally erode profits from earlier in the year, or whether banks will still manage to post a slight increase in trading revenue.
Still, the doldrums probably won’t be enough to derail what was a “sound year” for trading at the five biggest U.S. banks, according Goldberg. He estimates they’ll generate a combined $78 billion in trading revenue in 2018, the most since 2016, thanks to a stronger first half of the year.
Buckingham Research Group is less optimistic. It expects trading in fixed income, currencies and commodities to be a drag on banks’ fourth-quarter markets revenue as "widening credit spreads and flight to safety likely weighed on market making," analyst James Mitchell wrote in a note.
One thing is for sure: With so many risk factors - from the burgeoning trade war to the death of the Fed put to whatever is happening in Washington - banks better hope that traders return to the markets next year...
"If you’re a money manager, you’ve got your returns locked in - you don’t really want to do anything in December so you might just back off, particularly if markets are looking really choppy," said Christopher Wolfe, head of North American banks at Fitch. "You want Goldilocks volatility. You need some, but too much pushes people off to the sidelines."
...and don't opt to wait on the sidelines until a clear path forward emerges.