Volume and Volatility

What will today bring?

A couple quick points that I’d like to make:

1. VOLUME

Yesterday’s volume on the NYSE was a low for the year. The consolidated volume was $3.2 billion. The average this year was $4.15 billion. The average for the calendar year 2007 was $3.11 billion. The five-year average is $3.07 billion. Why does this matter? The volume of late has declined pretty significantly -- as you can see by 25% or more. Portfolio managers are sitting on the sidelines. They’re waiting for a catalyst to make a move. That move could be to the upside or downside, but when you see this kind of decline in volumes, it’s VERY TELLING. The market going sideways is not necessarily a bad thing, and consolidation in one price range can be viewed as a bottom to that range. But in order for the market to do something we need to see BIG volume. So are you thinking what I’m thinking? When I looked at these numbers, I thought the January, February and March timeframe, given the massive write downs and near collapse of Bear Stearns, must have caused those months to be exceptionally high. Here’s what we found: The March low in the market was on the 10th and we retested that low on March 17th. The volume from 1/2/08 through 3/17/08 averaged $4.34 billion. Since then, the declines in volume have been even larger than I expected. If you’ve worked on Wall Street the one thing you do know is that the worst (as in declining volumes) is ahead unless we do get a catalyst to fuel the market. The summer consistently brings the lowest volume of the year and we are only three weeks away from Memorial Day. Look out July and August. They could crawl by! 

2. VOLATILITY

Oftentimes, we look at something called the VIX, or the Volatility Index. It is a measure of investment psychology. It measures the S&P volatility or option activity. How many people buy calls versus puts and the kind of premiums they pay. So what does it mean when we see a low VIX reading like we are seeing right now? It usually means that option sellers are more aggressive than buyers and that options, in essence, are “cheap.” You could look at it two ways. One way is to say that option traders do not expect the market to do much in the near term and hence allow the premiums or the measure of those premiums, the VIX, to decline. The other way many market participants or traders will look at is with surprise. Normally a declining market suggests a high reading on the VIX, thus implying that traders are buying more downside protection (usually through puts) and therefore the VIX spikes. We may not be seeing extreme bearishness in the equity put/call ratio because of the aforementioned above, the absence of conviction, a near term catalyst and because some suggest the willingness to take on risk has declined. In fact, Michael McCarty of Meridian Partners says the tolerance for risk is rising. Risk is measured by spreads and he notes that spreads are tightening and he believes that is going unnoticed. He thinks we could be on the cusp of a break out to the upside!

Why should you care about all of this? It may mean that the market is due to for a top and a period of further consolidation. Ashraf Laidi from CMC Markets put it this way: “A high number reflects creeping fear, with a figure above 30 possibly suggesting excessive pessimism and selling. Conversely a low VIX suggests optimism or confidence in the market, with a figure nearing 10 suggesting possible complacency." Right now we are right in the middle of that range. As earnings season wraps up, where will the VIX go???? Keep an eye on it!!!!!!