Gauging the Chances of a Speculative Bubble

I’ve recently pointed to the high Nasdaq/NYSE Volume Ratio as a negative indication for stocks on a longer-term as well as a shorter-term basis. But history tells us that there are times when this ratio can remain elevated for extended periods, such as the late 1999/early 2000 period. We all know how that ended, but it’s noteworthy that the Nasdaq/NYSE Volume Ratio spiked above 2.0 a number of times beginning in November ’99. This usually preceded a sharp, quick selloff short-term, but the market was equally quick to bounce back as the speculative frenzy continued to defy odds. It was another five months, and a sharply higher Nasdaq, before the market put in its ultimate top. On Tuesday, this volume ratio closed above 2.0 for the first time in over five years. Could we be entering another period of sustained speculative buying, a final blow off from the huge rally off the March bottom? I didn’t think so a week ago. At the time, it looked like the S&P was topping out soon after its push into new highs on June 1st. The cumulative TICK 20-day moving average topped out earlier in May, and speculators appeared to be rushing into the market at just the wrong time. But since then, it’s been eerily quiet. Upside momentum has been minimal as the market consolidates its recent breakout, but there’s been no institutional selling. The time to trap weak hands was a week ago, just after the S&P broke into new highs. That time window has essentially come and gone without any meaningful selling. We may still see lower prices Wednesday, but what large investors are NOT doing (selling) might be the most telling indication of all. They’re still better buyers since the March bottom, and until that changes in a meaningful way, the market’s not going to gain any traction on the downside.

Emphasizing the lack of institutional participation recently, NYSE volume declined for the third straight session Tuesday, with just over a billion shares trading hands. I went back and noted each of the last thirty instances in which NYSE volume declined three consecutive sessions and the S&P500 lost ground in this time frame (as was the case at Tuesday’s close). In 22 out of 30 cases, or 73% of the time, the S&P500 closed at a higher level one week later, significantly above the 54% at-any-time odds for a higher SPX five sessions later…

NYSE Volume Down Three, S&P500 Trades Lower
06/09/09… S&P500 ??? one week later
04/07/09… S&P500 +4.5% one week later
03/04/09… S&P500 +1.2% one week later
01/26/09… S&P500 -1.3% one week later
01/09/09… S&P500 -4.5% one week later
12/24/08… S&P500 +7.7% one week later
09/24/08… S&P500 -2.1% one week later
09/11/08… S&P500 -3.4% one week later
08/25/08… S&P500 +0.9% one week later
07/28/08… S&P500 +1.2% one week later
03/27/08… S&P500 +3.3% one week later
10/04/07… S&P500 +0.8% one week later
09/26/07… S&P500 +0.9% one week later
05/14/07… S&P500 +1.5% one week later
01/08/07… S&P500 +1.4% one week later
12/22/06… S&P500 +0.4% one week later
12/08/06… S&P500 +1.2% one week later
10/30/06… S&P500 +0.1% one week later
10/02/06… S&P500 +1.5% one week later
06/26/06… S&P500 +2.4% one week later
04/10/06… S&P500 +0.9% one week later
02/13/06… S&P500 +1.6% one week later
02/03/06… S&P500 +0.2% one week later
11/08/05… S&P500 +0.9% one week later
08/05/05… S&P500 +0.3% one week later
06/06/05… S&P500 +0.3% one week later
03/14/05… S&P500 -1.9% one week later
01/07/05… S&P500 -0.1% one week later
12/31/04… S&P500 -2.1% one week later
12/27/04… S&P500 -0.2% one week later
10/22/04… S&P500 +3.1% one week later

Speculative-fueled rallies invariably end badly – see my June 4th commentary for a recent discussion – but the kind of NASDAQ/NYSE Volume Ratio that was registered Tuesday suggests we could be in the early stages of a speculative frenzy. If true, we should see two things… the Nasdaq/NYSE Volume Ratio should remain generally above 1.50 on a daily basis, and the NDX/SPX ratio should continue to trend higher as high-beta stocks continue to outperform blue chips. The latter was a particularly good indication when it began making lower lows for the first time in months at the end of March 2000, signaling a pop in the speculative bubble.

Categories : Archived EOD Commentary, End-of-Day Commentary

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