Stock Market Optimists Revisited: This Is Not Your Father's Stock Market

Having the privilege to have met Sir John Templeton, the founder of The Templeton Funds, I was stuck not only by his crushing intellect but also by his sense of optimism regarding investing. Warren Buffett, a fellow optimist, who upon acquiring Burlington Northern Santa Fe Corp. (BNI) for $26.3 billion said, “It was a bet on America”.

Optimistic Investing: Being an unblinking optimist has been a helpful personal affliction for successful investing post-WWII. The S&P 500 is up 65 times since 1950. On a weekly basis it has advanced 56% of the time. Prior to the most recent stock market peak in Oct ’07, you would have made money even if you were unfortunate enough to have purchased the DJIA at any of its peaks since 1900 (see accompanying chart). It was the equivalent of throwing darts at a dartboard with nothing but a “bull’s eye” on it.

Investors Buying with Conviction: Earlier in this period investors’ optimism was expressed in the fact that “up-volume” (a positive percentage change in average weekly share volume) was associated with a positive weekly price change for the S&P 500 index. Moreover, since 1950, the S&P 500 advanced 1.4 times on positive volume versus declining volume and price.

So, for the bulk of this period, investors were enthusiastic buyers and reluctant sellers of stocks. However, on that metric, investors may have a lot less to be optimistic about going forward in the volume/price relationship.

Less to be Happy About: The S&P 500’s weekly advancement on “up-volume” has declined from an average of 31.9% for the period to just 25.1% for the current decade. Optimist directional volume (up-volume on S&P advances, down volume on S&P declines) has steadily eroded from 58.1% in the ‘50’s to 46.8% in the ‘00’s.

More Bad News: On another discouraging note, the correlation of weekly percentage change in volume versus the percentage change in the index has drifted negative in the current decade. As of late, there is a greater percentage of higher volume associated with negative price changes.

The chart below tracks the 3 week moving average of the percentage change in the S&P 500 volume (inverted) with the change in the S&P 500 index since the stock market peak in 2007. The chart demonstrates higher volume on lower index value.
Not Your Father’s Stock Market: Some of this can be explained by the explosion of trading volume (average weekly volume is up 1,549 times since early 1950 levels), greater opportunity to short stocks, more complex trading strategies that employ hedging, option trading, the emergence of the hedge funds and the growth of offshore stock exchanges providing an alternative to domestic stock markets.

The other part of this explanation may be decreasing investor optimism regarding the prospects for the US economy and its equity markets. The former may just be the tools that reflect our waning conviction regarding US economic prowess.

The Next 10 Years: As we look to the next decade of this century we should be reminded of Winston Churchill’s quip, “A hopeful disposition is not the sole qualification to be a prophet.” Maybe it’s no longer the sole qualification for successful domestic investing. At the very least, we may be reluctant to rely on the volume-to-price relationship to be optimistic.

Comments

[damienhaas]

" you would have made money even if you were unfortunate enough to have purchased the DJIA at any of its peaks since 1900 (see accompanying chart). It was the equivalent of throwing darts at a dartboard with nothing but a “bull’s eye” on it. "

I think you forget about nominal gain is not inflation adjust gain.

2009 Nov 21 04:33 AM

[TradingHelpDesk]

The flagship large cap US index, S&P 500, closed near flat over the week 0.19% lower. The index remains more than 60% higher than its cyclical low seen early this year. Naturally after such a strong run investors are torn between banking profits and leaving their equity allocation intact on the hope the bullish trend will continue. Bears, (equity pessimists) are however increasingly citing the gap between stock prices and the underlying economic fundamentals which despite improving GDP data remain patchy or weak with rising unemployment the primary example.

tradinghelpdesk.ning.c...

2009 Nov 21 09:56 AM

[MarvinMBA]

I made my basic retirement by investing. The large increase in money supply will eventally pump up the markets again as well as the economy going forward...its going to be inflation that is real plus inflation expectations that are going to make the investing public buy equities. In spite of the recent downdrafts, some of the tech stocks like INTC seem to me very inviting for the long run inflation protection the public will seek. Besides INTC makes products that are going to be the core of future tech growth...MarvinMBA PS I'm concerned about gold continuing to climb and with increased interest rates on the horizon keep away from the precious metals.

2009 Nov 21 02:02 PM