Trader’s Narrative

For a while now, we’ve been concerned that volume hasn’t been powering the market higher. In fact, if you think of volume as fuel for any sustainable market rally, then we’ve been running on fumes for a few months. Since I wrote that in early June the market wobbled a bit and traced a shallow correction but before long it was on to new highs for the year. This has been a teflon coated rally.

But there is no mistaking that what we are seeing is a true outlier in terms of historical market performance. Here is a chart from Hussman’s most recent commentary which shows the six-month percent change in the S&P 500 from the bottom of each bear market (going back to the early 1940’s) compared to the percent change in volume over that same period:

Source: Hussman Commentary

As you can see, this rally is the largest one powered by the least volume. If we imagine a “best fit” line for the data, it would be going from the lower left to the upper right, implying that usually, the more volume, the bigger the recovery from a bear market low.

The state of volume (or lack thereof) is even more alarming when you consider that for the past year a baker’s dozen of stocks have grown to account for eyepopping proportions of total volume on the exchanges. Just to give you an example, on August 6th 2009 Citigroup (C) and Bank of America (BAC) accounted for 25% of total NYSE volume. Dr. Brett have brought attention to this last month: The Recent Concentration of Volume.

There are many theories about what exactly is behind this crazy volume: daytraders, HFT, short covering, secret government recapitalization, etc. Whichever reason is the real one, a market structure where total volume is distorted by such gigantic proportions from a handful of issues is, simply put, deceptive.

With earnings season once again around the corner, this perspective on the market has extra relevance:

Source: Decision Point

Once in a blue moon, the market trades at prices which take it to a “value based buying opportunity”. But notice that looking back, it hasn’t for a long time. According to this chart, if we do revisit that scenario again, we would be at levels last seen in 1996 (S&P 500 ~650).

Which reminds me of this other chart, showing just how low a serious bear market can take prices.

I highly recommend Decision Point, the source of the chart above. Thanks to Dr. Brett, you can have free access to their great site until October 26th, 2008. Just login as a regular member would using User ID: magic55 and Password: moments.