Is Economic Volatility a Bad Thing? Not for Brokerage Firms!

Unlike the smooth ride of 2013, last year shaped up to be a bit more volatile.

And December, in particular, closed with a bang. Stocks dropped more than 5% over eight days in early December, only to spike 6% higher by month’s end.

The Volatility Index (VIX) — the most commonly quoted measure of stock market volatility — ended December at levels that were 40% higher than in 2013. In sum, after sharp sell-offs in October and December, we closed the year with 12-month volatility at its highest level since 2011.

And while heightened volatility can be frustrating for passive investors, there’s one type of company that loves a healthy dose of volatility.

I’m talking about… brokerage firms.

In a way, brokerage firms have the best of both worlds… and can do well in rising and falling markets.

That’s because brokerage firms make money when their clients make trades. It’s usually of little importance to them whether you make or lose money — they collect their transaction fees either way.

The brokerage firm I formerly consulted for showed a clear correlation between brokerage fee revenue and market activity, meaning both volume of shares traded and volatility.

Simply put: When investors are buying and selling… brokerage firms’ registers are ringing.

Last October, as the market sold off by nearly 10%, volume traded on the SPDR S&P 500 ETF (NYSE: SPY) clocked in at 3.96 billion shares — the highest monthly volume recorded since the summer sell-off of 2011.

And as I mentioned above, December ended at the highest level of volatility since the summer of 2011.

More importantly, this active-trader trend seems to be carrying over into 2015.

Most of the major brokerage firms have reported January figures — what the industry calls DARTs (Daily Average Revenue Trades) — and the numbers are strong, showing increases in trading activity in the range of 5% to 16%, month-over-month.

Not surprisingly, amid this flurry of investor activity, brokerage firms’ stocks have been popping up on my radar.

While the S&P 500 has gained just under 7% in the last six months, brokerage firms have done much better, mounting gains of 10% (TD Ameritrade), 16% (E-Trade), 21% (CME Group), and 29% (Interactive Brokers).

What’s more, the iShares U.S. Broker-Dealers ETF (NYSE: IAI) is now showing outperformance momentum, relative to both the S&P 500 and the financial sector (XLF).

All told, this niche of the financial sector is really heating up and is poised to outperform over the next two to three months.

I shared this analysis with Cycle 9 Alert subscribers yesterday. And I gave them specific instructions on how to play this trend. Click here for details.