Charles Schwab (NYSE:SCHW) is one of the largest retail brokerage firms in the U.S. and earns around one-fifth of its revenue in the form of trading commissions. Over the past few years, this business has been badly hurt because retail investors chose to sit on the sidelines amidst the prevailing market uncertainty. The company’s trading revenue declined from $1.08 billion in 2008 to just $868 million in 2012, as the average number of trades executed by a customer in a year declined from 9.9 to 8 over the same period, according to our estimates.
However, the situation seems to be improving in the last few quarters. According to the data released on August 14, the brokerage’s daily average client trades for July were around 498,900, an increase of over 26% from the same period last year. This marks the eighth consecutive month in which the brokerage’s trading volumes have increased year-on-year.
So does this mean that the days of low trading activity are finally over? It might be still too early to tell. The continuous improvements in trading levels are definitely a good sign. However, there are still some concerns that make us doubt whether the improvement in trading volumes is here to stay as a lasting trend. In this article we discuss those concerns.
The Year-On-Year Growth Rates Are Influenced By Low ‘Base Effect’
The double-digit year-on-year percentage increases in volume levels should not be over-emphasized because they come on top of 2012 data, which was exceptionally low. For instance, the 26% year-on-year growth in July doesn’t seem so spectacular when one looks at it in the light of 2012 data. Schwab’s July 2012 volumes were just 396,100, significantly below the average levels of 463,500 that we have seen since July 2011. The low base of the year-ago period ensured that the year-on-year volume growth in July 2013 looked high (+26%), even though trading levels were just 8% above their average level.
We anticipate that the company’s average volumes for August 2013 will also show double-digit year-on-year growth in percentage terms, even if trading activity is not very high in absolute terms. In August last year, Schwab’s trading volume averaged just 375,900. So the trading volumes of August 2013 will appear to increase at 10% year-on-year, even if they actually decline by 20% month-over-month to just 413,500.
Sequential Growth Is Not That Strong
The month-on-month growth story of trading volumes also looks inconsistent. In January volumes grew almost 5% sequentially. However, the growth stalled in February and then reversed for the next couple of months. Then in May and June we again witnessed 7.5% and 2.5% month-on-month increases respectively, only to be followed by a nearly 4% drop in July.
|Jan 2013||Feb 2013||Mar 2013||Apr 2013||May 2013||Jun 2013||July 2013|
|Clients’ Daily Average Trades (‘000s)||504.7||506.1||486.0||470.0||505.4||518.1||498.9|
|Month-on-month increase (%)||5.1%||0.3%||-4.0%||-3.3%||7.5%||2.5%||-3.7%|
|Year-on-year increase (%)||7.7%||1.2%||5.3%||2.4%||16.9%||24.2%||26.0%|
Given that volume gains tend to reverse fairly quickly, it is difficult to predict how the next few months will play out. A clearer picture is likely to emerge only after we witness a few more quarters of continued growth.
Performance In 2013 May Not Continue Next Year
Even if we witness elevated volumes for the rest of the year, it does not necessarily imply that the next year is also likely to follow the same pattern. Take 2011 for example, after declining for two years in a row, trading volumes registered an impressive comeback in 2011 and were up almost 12% for the year. However, 2012 saw a reversal of this trend as volumes again dropped by almost 7%.
|Daily average revenue trades (‘000s)||292.6||285.8||270.7||303.8||282.7|
Uncertainty In The Markets Is Not Over Yet
In the past few years, the global financial markets have received several major shocks – such as the Great Recession, Flash Crash, Eurozone Sovereign Debt Crisis, and U.S. Sequestration – that have shaken the confidence of retail investors. As a result, these investors chose to sit on the sidelines (not trade) and allocated large portions of their portfolios to cash. According to The American Association of Individual Investors (AAII), the cash allocations of retail investors, at almost 23%, was at a 16-month high in March this year, and had only started to tilt slightly in favor of equities in April.  
While this is generally good news for equity trade volumes, we fear that the macroeconomic environment still has some surprises to offer and could scare away investors yet again. For starters, the markets are still fretting over the Fed’s future monetary policy and are likely to sway with each bit of mixed macroeconomic news. Wild movements in foreign exchange rates and shocks from the Eurozone are also real threats that could cause investor enthusiasm to dip.
Some Growth In Trading Volumes Is Also Due To Higher Number Of Brokerage Accounts
Not all growth in daily average revenue trades (DARTs) can be attributed to increased market participation of existing clients. In the past few years, leading brokerages have done a good job of attracting clients from competitors, and this has resulted in their overall DARTs to increase even though the average trades executed in a year by a typical retail investor remained low. Charles Schwab, for example, had almost 250,000 more active brokerage accounts in July 2013, compared to the same period last year. Going forward, it will be crucial for these companies to continue attracting new retail customers at a rapid clip in order to push their overall trading levels higher.
We currently forecast trading volumes to increase moderately in the medium term and then grow at a faster pace during the second half of our forecast window.
- AAII: Cash Allocations at a 16-Month High, The Big Picture, April 3, 2013 [↩]
- AAII: Retail Investors Slowly Climbing Back into Stocks, PragCap, May 2, 2013 [↩]