Courtesy of Doug Short.
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One of the oddest things to happen with the stock market since it has recovered is that the number of shares trading hands each day has slowly disappeared.
In the table that I have created for you below, I list the trading volume for the S&P 500 for each June since 2009 and the percentage change in volume from the previous June.
Trading volume on the S&P 500 has dropped 60% since 2009!
What’s happening here? How can the stock market rise year after year if trading volume is down?
It’s very simple, but I’ll explain this new phenomenon in a moment. First, look at the chart of the S&P 500 below. Pay close attention to the volume at the bottom of the chart. As volume on the S&P 500 collapsed, the price of the index rose.
Chart courtesy of www.StockCharts.com
Volume is collapsing because the number of shares companies have outstanding is being reduced at an accelerated rate. For example, in the first quarter of 2014, S&P 500 companies purchased $154.5 billion worth of their shares back (stock buyback programs). Over the trailing 12 months, S&P 500 companies purchased more than half-a-trillion-dollars worth of their own shares—$535.2 billion to be exact. (Source: FactSet, June 18, 2014.)
Add to the shrinking number of shares outstanding the fact that central banks have also been buying equities (see “Guess Who Is Pushing the Stock Market Higher Now”), and the number of shares to buy (supply) has really been sucked up.
Dear reader, we have a dire situation at hand. Companies on the key stock indices are buying back their shares in bulk (to make per-share earnings look better), and central banks are buying stocks because they don’t want to miss out on the returns. As this happens, “retail” investors are forced to bid prices higher as there is only a limited number of shares that can be traded. What do you get as a result of this? Rising key stock indices.
But when we look past the smoke and mirrors, we quickly see the fundamentals that drive the key stock indices like the S&P 500 higher are deteriorating; corporate earnings and revenues simply aren’t growing. Any investment analyst knows the key to a healthy stock market is rising volume (rising demand), not falling volume.
As interest rates start to rise, S&P 500 companies will not be able to offset lower earnings with stock buybacks because they will be paying more interest on the money they need to borrow to buy their stock back. Higher interest rates will also change the environment for central bankers and what they do with their money.
The risk in the stock market remains elevated. And all the hype aside, the Dow Jones Industrial Average is up only three percent for 2014 — a gain that can be easily erased.
Originally posted at Profit Confidential
© Michael Lombardi, MBA
