Sentiment, Price and Volume all Point to Continued Range
Thursday, July 1st, 2004 9:00pm EST
Rydex Rally
Bottom Line: Rydex traders are feeling quite content with the recent market action, which is usually a cause for concern by those who watch them.
In the intraday comments early this morning, I mentioned the extremely high level of our Rydex Beta Chase Index. Recall that this measure shows us the relative preference of Rydex traders for high-beta funds (which tend to be risky, as their moves are more exaggerated than the market in general) as opposed to low-beta funds (which are “safer” funds that move less than the general market). As the Beta Chase Index rises to a high level, it means that traders are becoming more willing to take on risk and eschew those funds that don’t move as much, thus the term “chasing beta”.
As of last night, the Beta Chase Index closed over 18, which essentially means that these traders have been 18 times more willing to “invest” in high-beta funds than low-beta ones. This is a demonstration of risk-taking that is unmatched in the four-year history of the data, other than when we were initially rallying off the major low in 2003. On 3/21/03 the Index closed just over 19, and that marked the top of the move in the short-term. I have no doubt that tonight’s numbers will change this picture dramatically, but one day of relatively mild declines does not erase the type of speculation we’ve seen the past few days.
Of additional concern is that assets in the money market at Rydex, as a percentage of total index assets, have slipped to their lowest level since February 2001. Assets were close to being this low in March of this year (which also isn’t encouraging), but the current level is slightly lower. When money market assets become very low, we can assume that these traders are comfortable with their current positions, and see no need to park their money in a low-yielding, but very safe, money market fund. Current money market assets are less than 27% of total index assets, compared to over 51% in July 2002, or even 40% in March 2003. To be fair, money market assets also became very low by November of last year, and we managed to tack on some very nice gains after that.
Lastly, as of last night, total assets in the bullish index funds at Rydex totaled $2.401 Billion. That is just under the high of $2.405 Billion reached on February 11th of this year. So although the Nasdaq Composite is 40 points below where it was on that date, the S&P 500 is 16 point below, and the Dow Jones is 300 points below (again, as of yesterday), bullish assets nearly match that date – another not-encouraging sign. Rydex traders, when aggressive in their trading, are poor market timers, and more often than not it pays to take the other side of the trade.
Speaking Volumes
Bottom Line: When we subtract out program trading, volume on the NYSE last week was at its lowest point since 1999. Also, traders have been shunning shares of ETFs, which has been a negative short-term sign.
I’ve touched a few times on the increasing influence of program trading (automatic buy and sell orders for at least 15 stocks with a value of $1 million or more) on the NYSE. I showed a couple of weeks ago how this activity has shown an extremely high negative correlation to the Specialist Short Ratio, likely destroying any use that indicator used to have. The most recent data, for the week ended 6/25/04, showed that program trading accounted for 70.5% of all NYSE volume. That is an almost incomprehensible number, something that nearly makes me think it is a reporting error. The previous high was 55.5%, which was set the week prior.
If we adjust total changed NYSE volume (on a weekly basis, to match up with the program trading numbers), then last week saw the lowest volume of any week since the last week of December 1999. The other spikes down in volume almost exclusively occurred during the last weeks of December, which of course reflects the great number of traders on vacation during that week of the year.
The chart below shows weekly NYSE volume, after taking out program trading. The tan horizontal line towards the bottom shows the current volume level, and it really highlights just how low this adjusted volume was last week, provided the program trading numbers reported by the NYSE are correct.
This is a very broad generalization, but typically high volume is associated with heightened interest in equities, which normally comes in bursts near market turning points. Low volume is more difficult to decipher, particularly during the summer months, but it is sometimes considered a bearish development, since traders are apparently comfortable enough with existing positions that they do not feel the need to get in or get out of stocks at current levels.
Somewhat related to this are the SPY and QQQ Liquidity Premiums. Recall that these measures compare volume in the exchange-traded funds to the volume in the underlying companies in the indexes. When volume is extremely high in the ETFs compared to the underlying stocks, it is a sign that traders are uncertain, as they flee to the liquidity and easily traded shares of SPY and QQQ. On the other hand, if traders are more confident about their shares, then volume in the ETFs tends to drop off relative to the underlying companies.
As of yesterday, ETF volume was at or near its lowest levels, relative to volume in the underlying companies. The Liquidity Premiums for both SPY and QQQ were at new lows, as the chart below shows (please note that the scales have been inverted to more clearly show overbought or oversold conditions). Today we finally saw increased interest in ETFs, but we have a ways to go before it could be considered bullish.
The red dots on the chart show the other times that both Premiums entered extremely low territory, and it typically coincided with at least some short-term weakness in the S&P 500. If regulators change the rules so that the uptick rule currently in effect gets reversed for at least some stocks (allowing traders to sell short stocks as they are declining, like they can do now with ETFs), then we may see these Liquidity Premium indicators lose some of their effectiveness. Until that happens, however, the current levels suggest we will see more weakness ahead.
Fed Pattern
Bottom Line: A look at past instances of both stocks and bonds rising on a Fed rate decision day may give a slight clue for future moves.
Near the close on Wednesday, I noted in an intraday comment that the fact that both stocks and bonds closed up on the day was not necessarily a good sign. The Fed only began explicitly announcing its target for the fed funds rate in 1995, so since 1996, anytime both stocks and bonds have liked the Fed's action by closing higher on decision day, the S&P was higher three days later only 5 out of 11 times, and the average return was -0.8%. After 30 days, only 4 times was the S&P positive, and the average return was -0.9%.
Those figures are for any Fed decision – whether they decided to raise, lower or leave rates unchanged. Anytime both stocks and bonds closed higher on a day the Fed raised rates, the S&P was lower after 30 days every time, with an average return of -3.6%. There were only four instances, however, and all were in 1999 and 2000. I’ve noted before how it is extremely difficult to use past reactions to economic data as a guide for future reactions, since what is considered “good” news is constantly changing, but this at least gives us a little perspective.
Conclusion
Today did nothing to change the longer-term view that I think is most likely going forward – in fact, it only reinforces it. I continue to believe that May saw an important intermediate-term low, declines that put us into an oversold situation should be viewed as opportunities to add or initiate long exposure, we should see modest gains for the year, but the best strategy will most likely take advantage of oscillating indicators (selling overbought conditions and buying oversold ones) rather than breakout strategies. The closer we are to the top of the trading range, the less inclined I am to be holding long positions. Vice-versa for approaches to the lower end of the range.
In the short-term, the slight overbought condition that some of our measures had entered by Wednesday’s close have evaporated and been replaced with a few oversold readings. Today the NYSE TRIN closed over 2.75 for the first time since May 17th, but of course at that time it was coming after a month of declines instead of after a month of rallies, which is a big difference. We will be in a period of relatively positive seasonality now, but I certainly don’t think that’s enough to be long just for the sake of being long. There should be more downside to come, and I continue to think that approaches to the upper end of the range should be used to sell, and not to expect sustainable breakouts.
Jason Goepfert
President and CEO
Sundial Capital Research, Inc.
Disclosure: no positions
This disclosure is not intended as trading advice in any form. It is meant as a note to subscribers that the author may have a position directly affected by the market outlook reflected in the commentary. Although the author takes great pains to remain objective in any commentaries, it is only fair that readers should know that the author may have taken positions in accordance with his market outlook. Positions can and do change at any time, without notice to the reader.
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