Much has been said about the decreasing market volume, and how seemingly every rally has a lack of participation. This view has been used to argue a bearish point of view on the market, however, I will use that view to argue a bullish point of view. The reason the volume is so low is because of a lack of conviction. Since there has not been a correction in over 3 years, investors are too nervous to put money to work. This is either because they think the market is overbought, or that the current fundamentals do not warrant the current S&P 500 valuation.
Despite the overall bullish tone of the market, the underlying sentiment is quite negative. That may seem peculiar considering that most analysts maintain a bullish stance on the market, but you would be surprised at how quickly that tone changes every time the market falls. Even the slightest move down in the S&P 500 causes tremendous rallies in the VIX. Just recently the CNN Fear/Greed Index went down to 4, on a scale of 0 to 100 (0 representing extreme fear and 100 representing extreme greed).
Why is it that a measly 5% correction causing people to be extremely fearful? Now I was not trading 10,15,20 years ago. But I am sure that when a 5% correction occurred people were not for the most part screaming bloody murder, as they seemingly are doing now. The takeaway is that we may still be in the skeptical/optimistic phase, not the exuberance or excess phase.
The low volume on every rally means that investors are still somewhat pessimistic and are not convinced of the idea of a global recovery and earnings growth. With the low volume, it is hard to get big sell-offs in this market. The reason is that if investors are not fully invested, there is not as much stock to be sold in corrective periods. In addition, most traders are scared to short the market for a prolonged period of time because of the central bank ‘put’ in the market. I think the low-volume rally lacking conviction is fine for the time being. To be clear, I am not calling for a big multi-year run, but I think that we will continue the overall trajectory higher at least until year-end. Just look at August of this past year; the volume was anemic, yet the S&P 500 rallied more than 3.5%. So what will cause a blow-off top/bull market top?
The answer, I believe, is a high-volume rally. This sounds counterintuitive, but I think that once all of hedge fund managers and mutual fund managers, who have underperformed the market, throw in the towel and start taking a more aggressive approach in the market, it will symbolize the entrance into the euphoria stage. Year-end is a critical period to ensuring profit has been made for the year in order for them to be considered successful. When everyone gets on the bull bandwagon, then the cash on the sidelines (another so called ‘put’ in the market) will dissipate. If we get another 20-40% year on high volume, I think that it will symbolize the end of the current bull run, because it will mean that most investors are fully invested in the market, and in turn will leave very little cash on the sidelines. If there is very little cash on the sidelines, the ‘buy the dip’ crowd will disappear, as that money would already be in the market. In addition, if everyone is fully invested, any future sell-offs will become more extreme as there will be more stock shares for sale, and there will be more margin calls. The more margin calls there are, the faster the market sells off, as people are forced to sell.