Nearly Every Day, Another Piece Falls Into Place
Thursday, August 12th, 2004 9:45pm EST
Speculation Subsides (somewhat)
Bottom Line: One of the pieces of data that urged caution in January is looking more positive now, though it is still not at a point that suggests we are at a bottom (as of July, anyway).
Back on January 18th, I noted several signs that suggested that if we were going to see a trend change and enter a declining market environment, then a decline was most likely to begin by early the next week. It just so happens that the next day printed the high of the year for the Nasdaq (more luck than skill, I’m afraid), but the point of the matter is that it helped to validate the measures we discussed. One of those measures was volume in low-priced over-the-counter bulletin board securities.
At the time of that comment, the total dollar value of the volume in those OTC issues was just over $4.6 billion, which reflected trades completed in December 2003. By looking at another measure, we showed that so far in January, speculative trades had been skyrocketing, and it turned that was also the case in OTC issues. When the January OTC volume figures were released in February, it was revealed that more than $7.2 billion in these low-priced shares had changed hands, a whopping figure the likes of which hadn’t been seen since April 2000. That certainly was additional confirmation that we had seen a “manic frenzy” reminiscent of the bubble days, and was just another data point suggesting we needed some cleansing of the excess.
Now that the Nasdaq Composite has declined some 18% from its January highs, it may be instructive to revisit those volume figures to see if traders have lost any of their speculative appetite.
The activity in January of this year clearly sticks out, as tiny-cap “investors” went into hyper-drive. Of the 3300 or so companies that were listed on the bulletin board at the time, the average stock traded an immense 820,000 shares per day – a new all-time record by far.
Even though the Composite was only down around 9% from the end of January through the end of July, the dollar volume traded in these speculative issues has declined by 63%. At $2.7 billion, the value of stock traded over-the-counter was the least in July since April 2003. While that is certainly a welcome sign that some of the excesses are being wrung out, it is still more than double the average volume during the wreckage from 2001-2002.
I don’t think we can safely say that traders have completely given up the idea of trading the lowest-priced, most speculative issues available. There still seems to be a glimmer of hope among that crowd that the heydays of 2003 could come roaring back, giving them a “ten-bagger” on their investment. We are seeing the lowest dollar volume traded now in well over a year, which is good, but I would prefer to see this volume dry up to under $1 billion during one of these months in order to more confidently say that a large majority of these traders were out of the game. The reason I say that is because in recent history, the only months showing less than $1 billion in total dollar volume traded in OTC stocks were April 2001, September 2001 and July – September 2002, all of course coinciding with pretty good times to be increasing our speculative activities.
NYSE Breadth Still Relevant
Bottom Line: For our purposes, using the breadth figures on the S&P 500 or the NYSE as a whole (closed-end bond funds included) makes no difference whatsoever.
I’ve been asked more than a few times lately about adding breadth figures for the S&P 500 to the site, as the NYSE figures are supposedly so skewed by interest rate-sensitive issues. I’ve talked about this before, and my opinion is essentially that while it may be interesting to view the NYSE data using operating companies only, the fact is that interest rates have ALWAYS had a large impact on the advance/decline figures, so I’m not sure why all the hubbub now.
To show how highly correlated the NYSE figures are to the S&P 500 (which, I’m relatively certain, contains only operating companies), the chart below shows the 10-day moving average of the up issues ratio that we post to the site. This ratio is simply the number of advancing figures divided by the sum of advancing and declining issues, which is just another way of looking at the advance/decline figures.
It’s quite clear that there is very little difference here. The S&P advance/decline figures are a little more volatile, which is what should be expected since it is made up of one-seventh the number of issues as the NYSE. The actual correlation between the daily a/d figures on the S&P and that of the NYSE is an extremely high .92 (on a scale of -1 to +1), which is close to saying there is no difference at all.
Over a longer time frame, or perhaps on a cumulative basis, we may begin to see some substantial differences between the two groups of statistics. But as far as our intermediate-term indicators go, using 10-day or even 21-day moving averages, as far as I’m concerned there is so little difference that it makes no difference which set of figures we use. There may be some valid arguments about how decimalization has affected the data, and I’ve talked about that at length before, but so far these indicators have continued to do about as accurate a job as they did before, so I’m still not ready to toss them out of our toolbox.
Conclusion
Nothing much has changed from last time. The Rydex data is looking better every day, put/call ratios are getting up there (except our nagging R.O.B.O. ratio, which I will once again eagerly await on Saturday), odd lot activity appears market-positive, ETF volume is heavy compared to their underlying component stocks (a good sign of trader uncertainty) and some longer-term breadth measures are now reaching extreme oversold territory.
However, like I have noted the past couple times, there remain some stubborn holdouts. The Investor’s Intelligence survey actually showed a very slight uptick in bullishness in their latest release. That marked the 27th time in the survey’s history that bullishness actually rose on a week that saw the S&P decline at least 3% (the last instance being the week ended January 24th, 2003…if that doesn’t sound familiar, please read the last comment). Surprisingly, though, the other occurrences of stubborn bullishness in the face of a weak market did not lead to more declines with a high degree of consistency – in fact, the market showed a performance about in line with any other week going forward.
I still think this is the most difficult juncture of the year. We certainly have quite a few pieces in place that could spring an excellent rally, but not enough to make it as high-odds as it seemed in March and May. So I’ll stick with my recent thoughts of holding off on adding long exposure until either those additional pieces fall into place or price action improves. A retaking of the 1075 level on the S&P would be a first step, and if that should occur, I think we have to give an increasing amount of respect to the possibility that we may have already seen the low for this move. I don’t think that’s especially likely.
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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