Another Warning Sign: Stocks Hit Highs on Collapsing Volume

The Only Bear Left StandingSo the S&P 500 has touched the 2,000 mark.

Will the S&P 500 continue to march to new highs?

Well, my opinion towards the stock market hasn’t changed. I remain skeptical for a variety of reasons, many of which I have shared with my readers over the past few months.

But I have a new concern about the stock market, something that hasn’t been touched on by analysts: trading volume is collapsing.

Please look at the table below. It shows the performance of the S&P 500 and its change in trading volume.

Year Performance Change in Volume
2012 11.73% – 17.58%
2013 14.50% – 24.91%
2014 8.40% – 44%*

*Until August 25, 2014

Data source: StockCharts.com, last accessed August 25, 2014

Key stock indices like the S&P 500 (it is the same story for the Dow Jones) are rising as volumes are declining, suggesting buyers’ participation in the stock market advance is very low. For a healthy stock market rally, any technical analyst will tell you that you need rising volume, not declining volume.

It’s Economics 101: rising demand pushes prices higher. In the case of the S&P 500, we have declining demand (low trading volume) and rising prices. Something doesn’t make sense here.

Looking at the economic data, it further suggests key stock indices are stretched. We continue to see the factors that are supposed to drive the U.S. economy to deteriorate.

Just look at the housing market. The number of new homes sold continues to decline. In January, the annual rate of new-home sales in the U.S. was 457,000 units. By July, it was down more than 10% to 412,000 units. (Source: Federal Reserve Bank of St. Louis web site, last accessed August 25, 2014.)

Major economic hubs are struggling. The three main economies in the eurozone are begging for growth. Italy is in recession, France’s economy is teetering on recession, and Germany’s economy is showing signs of softening. Today, the European Central Bank dropped interest rates again—but those lower rates are not spurring bank lending or consumer demand.

China and Japan, the second- and third-biggest economic hubs in the global economy, are seeing their economies slow as well.

Key stock indices are completely ignoring the worldwide economic slowdown.

Dear reader, irrationality and manipulation can run longer than anticipated, but not forever. The S&P 500 reaching 2,000 doesn’t really say or mean much except for this: the higher key stock indices go, the harder they will fall and the bigger the damage they will cause to consumer sentiment and the economy.