Strong finale to year possible

Christmas has come early in the Square Mile. That, ironically, is a popular complaint among City stockbrokers at the moment, who reckon trading volumes have fallen to levels usually seen during the festive period and say clients have lost all interest in the market.

While that is an exaggeration, there has been a marked slowdown in the past couple of weeks, with volumes back at the levels of the quiet summer months.

So far this month, the value of UK equities traded (both on the London Stock Exchange and all the other trading platforms such as Chi-X and BATS) has just topped €100bn, according to Thomson Reuters. That compares with €173bn for the whole of October, €155bn for September and a monthly average of €140bn during the year. There are just six trading days left this month.

The story is much the same on the other side of the Atlantic, where volumes have been below-average for most of November.

Equity strategists say the slowdown in trading can be explained by a combination of factors. One is a desire on the part of fund managers to protect gains after a painful couple of years.

“Our sense is that quite a few investors have performed relatively well this year and would like to keep it that way,” says Morgan Stanley’s Graham Secker. “If you are in the black then there is big temptation to shut up shop and wait until January to start swinging the bat again.”

Citigroup’s Jonathan Stubbs agrees. He says investors are “putting up the shutters” in an effort to protect their year-to-date gains. A fund manager who bought the FTSE 100 back in March would be sitting on a gain of almost 50 per cent.

The same is true for hedge funds. Some of the more successful funds are approaching their “watermarks” – the level at which assets under management reach previous highs and they can start charging performance fees again. They have a natural incentive to cut back on risky trades.

Another factor is that many investment banks and stockbrokers are approaching their financial year-end. They will want to present pristine balance sheets to regulators and their investors and will be reluctant to make any large bets that tie up capital.

Furthermore, many big investors still harbour significant scepticism about the sustainability of the rally and, with their concerns unlikely to be answered in the near future, they too will be reluctant to commit fresh capital to the market.

The fact that volumes are slowing does not necessarily mean the market will fall, although it is certainly something to be worried about. Compared with 2008, trading volumes have been lacklustre all year. And yet the FTSE 100 has enjoyed one of the most explosive rallies in its history. Indeed, there has not been a single month this year when the value of UK equities traded has totalled more than €200bn. In 2008 there were nine.

This is not as strange as it sounds. A similar pattern emerged after the dotcom bubble burst. After markets bottomed in late 2002 and early 2003, it was more than a year before trading volumes started to pick up again.

Strategists say the rally in UK and European equities since March can be explained by investors re-rating the market in anticipation of improved corporate and economic data. Traders believe the growth of computer-driven trading strategies has also played a part in the market’s move higher.

So it is entirely possible that the FTSE 100 will see a strong end to the year, even if trading volumes remain at current depressed levels. Which is good news because December stands out as one of the best months for European equities, according to Goldman Sachs. Based on data going back to 1974, it has found that December has on average returned twice as much as the monthly average (1.7 per cent versus 0.8 per cent) and has delivered even when performance has been strong in the preceding 11 months.

All of which should make City stockbrokers feel a little bit better this Christmas. Even if they have to wait until the new year to reap the rewards from their clients.

neil.hume@ft.com