Has Stock Market Volatility Ended Or Is It About To Resume?

By: Sy_Harding

Thanks to the rally of the last three weeks, which saw the S&P 500 quickly gain 12.1%, the market, which was down for the year just three weeks ago, is now up, the Dow and S&P 500 up almost 10% for the year.

So where are all the investors that should be piling in? They bailed out big time last year, and in the early part of this year, and they still are nowhere to be seen.

Oh I know, every other day we hear the cheerleaders on CNBC make remarks like “Investors really piled into the market today, and drove the Dow up 225 points.” But that isn’t really what has been happening. Trading volume has been drying up dramatically all year, very few “piling in”, instead increasingly standing aside, leaving the market mostly to day-traders and the big program-trading firms (which by themselves account for 40% of trading volume anyway).

Volume normally slows in the summer months as investors and traders enjoy vacations and are less interested in the market, particularly since the market is usually trending down in a correction during its unfavorable seasonal period that runs from May to October.

But this summer, volume has declined more dramatically than normal, even though so far the market has been making gains. Related to the old adage ‘Sell in May and Go Away’, the S&P 500 has gained 12.8% since May 1 (but thanks almost entirely to its 12.3% rally of the last three weeks).

There is a mountain of sideline money that could be piling in and could be providing important fuel to keep the rally going. Even after several $trillion of household wealth has disappeared in the last two years, thanks to the bear market in stocks and the plunge in home prices, there is still $4 trillion reportedly sitting in money market funds, earning virtually nothing. And as of mid-June that level had only declined 4%.

Contrary to claims, less than half of it is available for the market anyway. Roughly 60% of it is always parked in money market funds by businesses as their cash reserves, added to from earnings and dipped into for purchases of equipment, materials, and other non-investing business purposes.

The reluctance of investors to jump in is understandable, given the whipsawing volatility. It’s been a difficult year so far, in many ways more difficult than last year, when at least it was realized it was a bear market that would continue through the year.

While it sounds like an easy year to now be able to say, with the 20-20 vision of hindsight, that the S&P 500 is up 10%, the volatility has been brutal.

The year began with the market topping out from its rally off the November low on January 6, just as investors were becoming comfortable with the rally. It then plunged a heart-stopping 25.1% in just two months to its March low. By that time, fear and pessimism were at an extreme. Then bam – a rally began off the March low that had the S&P 500 up 17.5% in just 7 days, so fast that most probably missed that part of the rally. But the rally continued, although more slowly, and by early June it was 40% above its March low.

Then just as investors had become comfortable with a rally again, the market sold off for four straight weeks in June, and fear began to return, when even Wall Street conceded that the market had gotten ahead of itself and was due for a correction, perhaps even a retest of the March low.

But no, after declining just 7% in that four-week pullback, the market reversed again and surged up 12.3 % in the last 3 weeks.

It’s been a rollercoaster for both buy and hold investors trying to hold on, and market-timers trying to keep up with the reversals.

The reversals in opinions regarding the outlook for the economy have been just as dramatic; in fact have been creating the market’s reversals. Those opinions about the economy are about all investors can look to for guidance at this stage of an economic downturn.

In good times, the economy is growing and so are corporate earnings, and it’s mostly a case of picking the best stocks or sectors that will most take advantage of the good times. In bear markets it’s mostly a case of getting out of the way, and picking off some profits from short-sales and inverse etf’s and mutual funds.

But in between there are these periods when the outlook is uncertain and opinions vary all over the lot. The economy is still slowing, corporate earnings are still plunging, consumer confidence is still declining. Yet they may not be declining as rapidly, which may be an early sign of a bottom - or may not.

Does the pick-up in home sales and home prices of the last couple of months indicate a bottom is in for the housing industry? Or is it just the normal seasonal pick-up in the traditional spring home-buying season, with more problems to come from the growing number of foreclosures?

Has the whipsawing volatility ended and morphed into a long-term trend and multi-year bull market? Or is the market ahead of itself in its euphoria?

A couple of things to consider are that the major indexes have become very overbought technically, for instance very over-extended above 20-week moving averages, a condition frequently seen at intermediate-term tops. And the 2nd quarter earnings reporting period is just about over, and there is no argument that the bullish interpretation of those reports have been the main driving force of the last three weeks of dramatic rally.

Sy Harding publishes the financial website www.StreetSmartReport.com and a free daily market blog at www.SyHardingblog.com.

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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