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By Amey Stone Low trading volume, rather than price gains, has been the dominant characteristic of the stock market throughout June. That may not sound like a big story -- especially since stocks have managed to drift up (the benchmark Standard & Poor's 500 has risen 3.5% over that time). But talk to traders, and they you'll find they have been scratching their heads over why investors are sitting on the sidelines. "We've been banging that question around for three weeks now," says Brian Williamson, an equity trader for The Boston Company Asset Management. On the New York Stock Exchange, daily volume in the past four weeks has been as low as 1.1 billion, down from the 1.5 to 1.8 billion range during most of 2004.
The risk for investors is real. Even though major indices are flat for the year, having barely budged in recent weeks, low volume does not necessarily mean a stagnant market. In fact, the impact of a buy or sell order from a large investor is magnified when there are fewer trades being placed. "Thin markets are easily moved," says Trip Jones, managing director of sales at SunGard Institutional Brokerage. Plus, trading in this market is even thinner than it looks, since computerized program trading makes up more than half of all volume (but only affects trading for a few minutes at a shot). "That makes the market inherently dangerous," he says.
WAIT AND SEE. So far, seasonality is taking most of the blame for the slowdown. But we're hardly in the dog days of summer. Last year, low-volume days didn't kick in until August. So what gives?
One oft-heard explanation is that investors are waiting until June 30, when the Iraq handover and the next rate-setting meeting of the Federal Reserve both occur. The theory is that with those events out of the way, investors will return to equities. But "it's hard to believe they are waiting for June 30 to lift all overhanging clouds," writes Wachovia Securities' Larry Wachtel in a June 22 note, "but that seems to be the chitchat."
Perhaps it is just idle chatter. After all, investors can hardly be waiting for the Fed, since the Street has all but agreed that it will raise rates a quarter point, says Robert Turner, chief investment officer at Turner Investment Partners. And it's also pretty clear what the situation in Iraq will be: Says Jones: "Iraq will get hotter and nuttier coming up to that date, but it will get hotter and nuttier immediately after as well."
THE CHINA CARD. The real reason for the low volume may be that portfolio managers don't really know what to do next. Many suspect that stocks won't be able to do more than tread water in a rising interest-rate environment -- even if earnings growth remains robust. Despite the strong economy, Turner believes they remain fearful of investing in growth stocks, having been burned in the three-year bear market that preceded 2003.
Most pressingly: As statistics continue to show inflation creeping up, many investors are worried that the Fed is behind the curve, and that interest rates will have to move higher than currently anticipated in order to tamp it down. The Fed statement released after its policy-making session on June 30 will address those concerns. But that will only appease investors until the release of the next monthly jobs report, due in early July, and mid-July's Consumer Price Index (CPI). Satys Jones: "Every CPI and employment report is going to be an event."
In this skittish environment, staying on the sidelines makes good sense, since the market could have a major reaction to even a small piece of news. Hot buttons include anything to do with China's economy or the supply of oil out of the Middle East (since both could either heighten or dampen inflation fears), and market swings could be dramatic.
Barring any geopolitical events, earnings season, which kicks into gear in a few weeks as the second quarter ends, will likely get the market out of its malaise. Turner thinks investors will be pleasantly surprised by the strength of earnings and the health of corporate balance sheets, believing they will demonstrate a newfound willingness to pay higher multiples for stocks.
BUMPS AHEAD? However, if the market ignores good earnings, that would be a bad sign, says Jones. "Our gut sense is that we haven't seen the lows yet on this correction," he says. He thinks the bull market will resume once it is clear that inflation is under control and price-earnings multiples reflect higher interest rates. But, thanks to the low volume and skittishness of investors, it could be a rocky road until we get there.
In the meantime, many big institutions and even individual brokers are reluctant to put their clients' money to work, say portfolio managers. "Trying to convince brokers to put money in a growth fund is like pulling teeth," notes Turner.
Even the usually fast-and-loose hedge funds are on the sidelines these days. "They are like deer in the headlights," notes Matthew Kelmon, who monitors market volatility for funds he manages at Kelmoore Investment in Palo Alto (Calif.). "They aren't taking any positions long or short."
At some point, that will change and volume will return to more normal levels. Until then, the smart investor will want to remember that low-volume markets can be full of surprises. Stone is senior writer for BusinessWeek Online