Sunday, October 4, 2009

Trading Volume Separates Bull Markets from Bear Rallies - Part 2

In April, I highlighted a market volume study by Bill Hester of Hussman Funds, where he noted in "Trading Volume Separates Bull Markets from Bear Rallies" that bull markets have typically begun on strong volume after selling had become exhausted. Since Supply and Demand are the fundamental drivers for price movement, Hester's analysis provides valuable insight as to the nature of the current rally and possible future outcomes.

In his latest market volume study, Hester writes, "This chart (above) updates one of the graphs for the elapsed time from that earlier piece. The vertical axis measures the six-month percent change in the S&P 500 from the bottom of each bear market going back to the early 1940's. The horizontal axis shows the percent change in volume over that same period.

Familiar durable bear-market bottoms stand out, like in 1982 and 1974. These rallies had strong returns that coincided with large bursts of trading volume during the first six months of the rally. There are a couple of examples, like 1998 and 2003, where bull markets had a good start on mediocre expansions in volume. But for the most part, in the cases where volume contracted the bull market beginnings have been uninspiring. More common is a strong increase in volume that coincides with gains of 20 to 25 percent during the first six months. It's clear that this year's rally is an extreme outlier in the dataset, with above-average returns and a continued contraction in volume from the levels of trading in March."

Hester goes on to break out the volume of a handful of "phoenix" stocks that account for a huge share of the volume of this rally, such as AIG, Fannie Mae, Freddie Mac, Citigroup and Bank of America. When the Phoenix stocks are taken into account, the volume story is even more ominous. For Hester's full report, click here.

Rather than base our investments on predictions, the Strategic Growth Model will continue to align its capital with the current market conditions, profiting from the statistical edge the system provides over the intermediate timeframe. For now, the intermediate market trend is UP.

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