We’re at the mid way point of the year and the second half is likely to be every bit a thrilling as the first half. Unfortunately, we’re likely to erase much of the gains we’ve made in recent months in the second half, so we’re not necessarily talking about thrilling in a good way. Of course we intend to make the best of a bad situation with put options.
Although they’re correcting today, stocks don’t appear to want to go down just in earnest just yet; they may hang in there for several more weeks. By August the downward trend should be more pronounced. In the meantime, we’re concerned with the lack of trading volume and the prominent role program trading is playing these days.
In the week ending June 19, the latest for which data is available, program trading accounted to more than 40 percent of the volume on the New York Stock Exchange. Liquidity is generally a good thing, but when so much of it is coming from automated trading we can’t help but think the greater fool theory is at work. Program traders have become conditioned to expect early morning and late-day buying. What’s more, stocks have typically bounced once they’ve fallen to important support levels. That has created a Pavlovian response to buy, with traders confident that others will follow suit.
The problem is little or no attention is being paid to fundamentals. With the economy not showing meaningful signs of improvement, eventually the piper will have to be paid. And if this currently important source of liquidity starts to dry up, stocks will likely suffer another severe setback. It’s worth noting that corporate insiders are stepping up their selling, perhaps telegraphing that all is not well.
That’s certainly the message from our short-term market timing tools. Of course there’s no lack of instances in which the market remained irrational for extended periods. The 880 level on the S&P 500 is key support we (and everyone else) are focusing on. Perhaps even more important is the 850 mark. A move down to that level would represent a 10 percent decline from the market’s recent closing high. Declines of that magnitude are typically followed by even greater losses.