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Aug162010

The "Drive By" Market

Monday, August 16, 2010 at 10:51AM

It's hard to remember a time like the present where the financial markets were so driven by the news of the day rather than longer term trends. The EU bank stress tests, for example, were all we could talk about on the Friday they were released in July, but by lunch time the following Monday investors had already moved on. How many times during the current earnings season did we have a day where stocks sold off due to one bad report, only to rebound the following day when another company reported a good number? On one day, investors will buy anything with a ticker, but then the next day they won't touch stocks with a ten foot pole.

This phenomenon is what we call the "drive by" market. Investors and the market are no longer looking forward to what's ahead. At the same time, we ignore the rear view mirror for historical perspective, trends, or parallels. Instead, we are looking out the side window. As we muddle along, instead of anticipating and analyzing, we react. When something comes into view, it gets our attention and we act, but the minute we pass it, it’s gone for good. This morning's monumental event is ancient history in the afternoon.

One manifestation of the "drive by" market can be found in the daily net advance/decline (A/D) readings for the S&P 500. As shown in the chart below, from 1990 through 2006 the number of days where a net of 400 (80%) stocks in the S&P 500 moved in the same direction never exceeded 20 and averaged five per year. Since 2006, though, the number of 400 days has exploded, and this year is on pace for at least 50 days. That's about once per week! It's not uncommon for day to day volatility to increase during market downturns, so the big increase in 2008 can be partially attributed to the bear market, but that still leaves 2009 and 2010 where even though the bear went into hibernation, day to day volatility thrived.

It's difficult enough to invest in a market where there is little in the way of conviction on the part of its participants. Exacerbating the problem now is that investors are armed with bazookas instead of revolvers. It used to be that if the market had a big up or down day, investors would use the move to either buy on weakness or lighten up on individual positions. These days, however, hair trigger investors armed with single, double, and triple leveraged ETFs and little confidence in their views create exaggerated moves from one day to the next.

While there is no way that we can change the environment we invest in, knowing is half the battle. As long as we are aware of the environment we are in and its causes, we can take steps to avoid its pitfalls...and duck for cover.

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Reader Comments (4)

This is due, in no small part, to the numbers of non-humans in the market. Yes, I meant the algos. Retail is dead, say hello to SkyNet or HAL9000, or whatever you want to call it.

With robots front running each other millions of times a day, the market moves up on fumes with no participants? How else does one explain 15 or 16 consecutive weeks of equity fund outflows during a period where the S+P moves up some 7 percent?

Our markets are horrifically broken, and this will all end with weeping and gnashing of teeth. All while the SEC continues to root out new porn sites to review.

August 16, 2010 |

Ivan

I think the high correlation between stocks and the underlying index has to with the explosion in growth of ETF trading especially by hedge funds doing basket trades, they make up most of trading volume and aren't trading stocks individually but rather grouping them all together to trade their own synthetic index against another, the market has changed and it ain't a stock pickers market, your better of playing the index with either the emini's or the SPY ETF.

August 16, 2010 |

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