As the market continues its steady grind higher, it is hard to find a day without some new piece of cautious, alarming or worrisome information being published by amazingly smart, accomplished, and persuasive people.
One particular type of a “Chicken Little” argument that is constantly put out there and pervasively perpetuated goes something like this:
- This market rally cannot be trusted because the market is rallying on low volume
I believe I have seen at least two versions of this argument on StockTwits this past week alone and every time I see it I get the urge to locate the nearest sharp object and stick it in my eye.
To state the obvious first: If you stayed out of the market for the past five years because this has been a “low volume” rally, you have missed out on a roughly +150% rally in the S&P 500.
More importantly, the “Low Volume” argument is superficial and just plain wrong in my opinion. Let me tell you why I think so.
Attached is the weekly chart of the S&P from 1999. There are several points worth noting:
- From 1999 to 2013, the average weekly volume on the S&P has gone from about 5B to 12B shares, that’s roughly a 140% increase (blue trendline)
- The huge spike in volume in 2008-2009 was due to the financial crash/meltdown and massive forced stock liquidation associated with it. As a result, this volume should not be used to measure long term volume trends. Statistically speaking, this period is an outlier
- Finally, the decline in the volume since 2011 (green trendline) as the S&P rallied some +70% is a result of stock prices rising across the board (more detailed explanation is below)
Regarding the lower trending average volume in the last few years, it is almost entirely a result of the rising stock prices:
- The average S&P stock price has increased almost 20% in the last three years
- At the same time, the number of companies executing stock splits has been near all-time lows
- This will naturally lead to lower volume of shares traded
Bottom line: Current volume trends are basically meaningless in terms of gauging the strength and health of the market rally. This is an incredibly strong market and it can stay this way for a lot longer even if volume continues to decline.
Please keep this in mind next week when we will undoubtedly see another “The Sky Is Falling Because Volume Is Low ” article.