Volume Continues to Fall

One of the bear camp’s big gripes about the current rally – other than the idea that it came out of nowhere and caught the nattering nabobs of negativism flat footed, of course – is the fact that volume has been lacking. As any chartist worth their salt will affirm, a market doesn’t need volume to fall but a strong, sustainable rally should be accompanied by increasing volume. In short, rising prices being accompanied by rising volume represents strong demand. As such, our furry friends contend that the current joyride to the upside isn’t long for the world.

While I vehemently disagree with my bearish buddies on the subject of what the market can or can’t and/or should or shouldn’t do, I will agree that volume hasn’t been a confirming factor for some time. In fact, the trend of total volume (I’m looking at the 50-day moving average of Total Volume on the NYSE here) has been in decline since late August – when the market first bottomed.

What’s more, if you take a step back and look at the bigger picture – via a weekly chart – you will find that 10-week average of total volume on the NYSE is at its lowest point since the turn of the century. And after hitting a high of 2.1 billion shares in the summer of 2007, the 10-week average now stands at just 839 million, which is less than 40% of the high water mark.

Thus, the first point we may want to consider is that declining volume is not something that can be attributed only to the current run for the roses. No, volume has been declining steadily for years. The second point to look at is that since the big bear began in the fall of 2007, the periods of increasing volume were also accompanied by sharply falling prices.

From my perch, this would seem to suggest a couple things. First, that volume increases when fear is on the rise. Given that the stock market hasn’t exactly been a bed of roses over the last 12+ years, investors have learned that buy-and-hold is a failed strategy. Thus, whenever things get ugly, the public has been making a beeline for the exits. Now factor in the insane volatility that took place last year and I will conclude that one of the primary reasons that volume continues to fall is the public has simply given up.

So far we’ve got fear and the fact that the public isn’t buying into Wall Street’s game anymore as reasons for the decline in volume. But, as they say in the infomercials, but wait, there’s more. Let’s not forget that the Credit Crisis not only beat the public’s finances to a pulp, it also obliterated the trading books of the big Wall Street banks and the hedge funds. As a result, leverage is no longer an easy way to a brand new Ferrari for hedge fund managers every year. And with the fast-money types no longer being levered up 30- and 40-1 on their can’t-lose, algorithmic trades, there is less trading going on.

Another thing the Credit Crisis bear market did was create a whole bunch of new regulations (because clearly more regulators do not see the problem or do their jobs is the answer!). And one of those regulations is a little something called the “Volcker Rule.” The implementation of this rule, which isn’t an altogether bad idea if you ask me, meant that Wall Street banks had to choose between being a hedge fund or a bank as they no longer could count on their proprietary trading desks to print money. Again, the bottom line is this has led to less volume being traded.

Given that volume has been in decline for a variety of reasons, I’m not buying into the bear camp’s argument that the current rally is fundamentally flawed. No, I believe the most important thing to watch with regard to volume is supply versus demand. So, when we plot supply volume against demand volume on a chart, we want to see demand volume crossing above supply volume during rallies. And while there is certainly room for improvement in this indicator, it is clear that demand volume is above supply volume at the present time. And based on historical data, the S&P has gained ground at an annualized rate of nearly 12% per year (versus an average decline of -2.7% per year when supply volume exceeds demand volume).

So, although volume is in decline, don’t listen to the bearish argument that stocks can’t rally unless volume is advancing because it just isn’t true.

Turning to this morning… This just in… Reports indicate that Greek political leaders have reached an agreement in order to meet the troika’s demands for additional bailout funds. Stock futures have moved to the highs of the day on the report.

On the Economic front…Initial Claims for Unemployment Insurance for the week ending 2/4 fell by 15,000 to 358K, which was below the consensus estimate for 370K and also last week’s revised total of 373k. Continuing Claims for the week ending 1/28 came in at 3.515M vs. consensus of 3.492M and last week’s 3.451M.

We will also get reports on Bloomberg’s Consumer Comfort Index and Wholesale Inventories later this morning.

David Moenning
Editor:  Short-Term Market Manager