Young and Invested

Hi investor – enjoying 52-week highs for every stock in your portfolio? It might stay that way for another year or so, despite the recent declines in aggregate market trading volumes. There’s no denying that we’ve been in a seasonal bull market rally for the last year, as started by the rocketed sell-off volumes in March 2009 that marked the ending of the seasonal bear market due to massive government stimulation (which have continued to-date).

Since March, trading volumes have continued to level out (see graph below), which has intensified the debate on whether the bull rally is indicative of a W-shaped recovery or just a pause in the climb up. Psychologically, it takes time for investors and traders to get used to a new milestone market level (such as this 52-week high), so I believe this is just a pause in the climb up; a lot of main-street and smaller retail investors are in shell-shock and watching on the sidelines. With the momentum acquired in the last 52 weeks, it doesn’t require massive volumes to maintain the trend. There’s still room to move up.

A very interesting 2-year technical analysis using the S&P 500 as an example (while DJIA Index exhibits the same patterns) shows a moderate-negative correlation between price levels and volume levels. Towards the “crash” (black candlesticks in the chart) of March 2009, you can see volumes exploding more than two-fold (blue line in the chart) as buyers were scurrying away; during this year, volume has been on a downward trend as prices have been increasing. A recent S&P correlation analysis explains this relationship between price and volume has existed on a yearly and even monthly basis since the 1950’s, providing a correlation coefficient of -0.29 (monthly) and -0.3 (annual). The chart below exhibits this visually.

Implication? Low trading volumes are not indicative of an upcoming fall in prices. This recent fear of low trading volumes is a psychological effect to a different trading level. Low volumes are not causal of price level increases, but they are NOT causal of price level decreases either. This is my first reason for believing that price levels will not fall in the near future. Reduced trading levels naturally lead people to believe that prices will soon be falling, but history has proven this is not necessarily the case.

Low volumes are noticeably seen by some as unwillingness by main-street investors to invest or trust their advisers. The way I see it is if mostly Wall Street remains in the markets right now, it’s even easier to influence the market with larger amounts of capital, and Wall Street is definitely bullish. Wall Street investors have been and will be bullish as long as the government stimulus continues, interest rates remain low and the dollar devalues. This is because most of Wall Street has guidelines for taking big positions that a lot more political than main-street and must adhere to certain indicators and principles – and Wall Street just loves their government stimulus and low interest rates for justification to be bullish on equities.

It’s important to recognize that there is still a lot of confusion in the North American markets. The economy is not in good shape, and the Fed seems to think that consistently forced stimulus and rising debt will somehow avoid the inevitable problems of today. To believe that this short-term trend represents any long-term economic improvement is ignorant. Looking at company valuations, income statements and fundamental economic indicators clearly depicts that the market is increasingly detached from reality.

But, that’s EXACTLY the reason I remain bullish for the short-medium term. You can reap the benefits from an artificially created increase in the markets while it is available. 

How long should you stay bullish for? As seen above, low trading volumes are not a useful indicator to predict a fall in price levels, and as long as the government stays consistent with its actions, market prices will continue to rise. An economic “recovery” (real or fabricated, you choose) is at the top of the Fed’s priority list, and thus they have VERY clearly stated their position to continue stimulus and low rates. The continuous economic programs and stimulus have continued to-date, and let’s face it, if the Fed was going to raise interest rates to battle any signs of inflation, it would have been raised by now. Based on the low-volume implications above, and assuming stimulus, Fed liquidity, ultra low interest rates and dollar devaluation continues, the markets will continue rising until the government’s and Fed’s intentions appear to deviate from their actions-of-late.

So for now, why not stay invested, make some money, and enjoy the upcoming 52-week highs.

Image credit: net_efekt under a Creative Commons license. 

Last 3 posts by Daniel Eskin

• Short-term Versus Long-term Investments - March 16th, 2010
• Expert Interview - Puru Saxena - March 9th, 2010
• Memory of a Crisis - March 8th, 2010