the Science I Don't Understand
It seems easy for the public to believe that the stock market doesn’t require a lot of reflection or deep thought because it is a bull market. The simple logic is that if it corrects, the long term will always save the long term investor. This piece of logic cannot be refuted based on any market behavior since 1982. The short term lesson of the short term bear market was to hold for the long term regardless of market behavior and valuations. This was the lesson reflected in most folk’s minds immediately before the 1999 to 2003 bear market. And while this dogma may have been dismissed by many during the timeframe where investors suffered, it has again been embraced by both professionals as well as the pubic. There has been a lot of discussion in a wide range of media on when the public is going to embrace this bull market. The premise of these discussions points to a public that is not behaving like they did toward the end of the last bull market. They say that instead of embracing the bull market with a wave of day trading maniacs, the public remains largely skeptical of the bull market. Many professionals, including most that are paid to be bullish all of the time use this observation to suggest that the bull market will continue for an extended period of time as the public whole heartedly joins the bull market fray. And with that, the bull market will have found its buyers (or suckers) of last resort. They are puzzled that this expected behavior has yet to occur.
While such logic contains substantial basis, I think it is far from a sure thing. There are several other factors that need to be considered that suggest, “This time it really is different”:
Therefore, it would not be wise to expect that the bull market must continue until the public “enters” as the sucker of last resort.
Discounting Mechanism? Not Near Market Tops!
A bull market “climbs a wall of worry,” and such is the case with this bull market. However, there is equal wisdom in the saying, “the stock market is a discounting mechanism that discounts the future.” It is this saying that suggests we are close to a market top. Why? Because today’s stock market not only doesn’t discount the future, but it barely discounts the present. This is evident by the amount of significant moves that are occurring the day of quarterly earnings announcements. Tuesday’s Amazon.com quarterly results are especially reflective of a market that not only doesn’t discount the future, but barely discounts the present. It was up over 20% on Wednesday’s trading. Similarly, one of the most visible and scrutinized companies in the word, Apple Corp., was up about 10% in after hours trading based on its after hours quarterly earning report.
A more accurate view of the stock market as a discounting mechanism is that at market bottoms, the market is extremely forward looking as it begins to move higher. The discounting window moves to shorter and shorter term time frames as the bull market ages, until finally at the top, very little if any of the future is discounted. The recent behavior of these large and visible companies to trade instantly and significantly higher based on what is announced the day of quarterly earnings, is a sign of a market that is not discounting far into the future if it is discounting the future at all.
A Different “Wall of Worry”
Speaking of the “wall of worry,” something about the market volatility index as measured by the $VIX index is suggesting that some market conditions may be changing. (As background, you may want to read, “A Short Look at the Volatility Index”). In the chart below, it is clear that the S&P 500 volatility index has formed an easily identifiable uptrend. While the trend may not be as apparent from daily action (ghosted), the intermediate and long term moving averages are illustrating that volatility is trending upward. Since the $VIX is known as a measure of market “fear,” some have dismissed rising volatility as simply the market’s way of “climbing a wall of worry.”
While this may be true, a look at the long term behavior of the $VIX is also relevant. The long term chart below which covers from the early 1990s to the present shows the high teens as an important technical area for the $VIX. The mid 1990s to 2000 bull market was accompanied by a VIX which moved between 19 and 35. This market actually climbed a “wall of worry” at that time. The bull market from 2002 to the present was largely accompanied by falling volatility as measured by the $VIX. One could say that this was a market climbing a “cloud of complacency.”
In the last year, the $VIX has spiked above 17 several times, but each time this occurred with an accompanying sharp correction of the S&P 500. However, most recently, the behavior of the $VIX seems to have changed its character. While the market has risen to new all time highs, the $VIX approached its previous “sharp correction” levels. In addition there is a clear trend toward a rising $VIX on falling market days, and falling $VIX on rising market days. What exactly does this mean? It only means that if a bull market “climbs a wall of worry,” then in the most recent action the market is climbing a different wall than it climbed from the 2002 rally onward.
Buying call options on the $VIX appears to be a reasonable “bet” when the $VIX pulls back to near its 50-day moving average. (You must use caution and study the behavior of the spot $VIX relative to the various price and term call options since they don’t behave like stock or index options.)
S&P 500 Trading Volume – Something is “Going On"
And speaking of “all the science I don’t understand,” I’d like you to give some attention to the daily trading volume trends on the S&P 500 ETF shown in the chart below.
Here you see a sharp jump in trading volume of the S&P 500 ETF occurring exactly concurrent with this year’s late February sharp market correction. The sharp increase in ETF daily trading volume is continuing, especially in the most recent trading. Wednesday’s S&P 500 trading volume was over 250 million shares which is 66% greater than the average daily volume and almost 4 times what an average day’s volume had been in the beginning of 2007 – a few short months ago. Clearly such a sudden jump in trading volume in such a liquid trading vehicle would not occur by “coincidence” – there would have to be a reason. The reason is part of all the science I don’t understand. Here I must call on anyone who knows or has a good idea on why the sharp spike in S&P 500 trading volume is occurring to share what they know by email.
The market had a rough time of it today, and in spite of this it put out a pretty big “tail” in the S&P 500.
Here’s today’s action with each bar representing 5 minutes of action. Notice the increase in S&P ETF trading corresponding with today’s market recovery.
So all we can say about this is that there is something going on, and we don’t know what or why. But something is going on, and I wonder who knows what that they can and will share.
A couple of important charts:
Countrywide (CFC) where 30 is an important technical level which was challenged many times over recent years and not yet decisively broken. Has the credit bubble busted yet? In my view failure to hold 30 would suggest the answer is “yes”. Let’s see if they can save it. I think the publicly available insider trading information which suggests the company’s stock flows from ATM’s in the company lobby, speaks volumes about what is going on with regard to this stock.
JC Penny, an important retailer which has completed a head and shoulders reversal pattern. Two weeks ago, it was up strongly on “good news” which occurred “the day of”. The market, discounting the present, rallied strongly right beyond the neckline and the stock also tickled the 50 day moving average before turning back toward its current intermediate term direction of down. Now it sits on 70, and failure to hold would be spelling that the market is done discounting the present and is now discounting a difficult future for the US consumer.
While all of this is going on, the public is going to stick with the philosophy that has served them well since 1982 – hold on for the long term. Let’s see if it works out for the baby boomers.
In the meantime, certain important powers are clear on the importance of maintaining the wealth effect in the US through inflated asset values. This grip has been lost in real estate probably for many years to come. But there is still a lot of hope with regard to the other US-public-owned asset - stocks. If stocks were to correct significantly, even to a level where stocks would have some semblance of fair value, it would kill the wealth effect and the loss of confidence would snowball throughout the US economy. This would be especially leveraged upon the retail stocks which are now very sick.
Enjoy and be well.
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