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Posted by on Oct 31, 2014 in Ranger Alternative Management

Buyer Beware: A Notable Divergence

Buyer Beware: A Notable Divergence

By John Del Vecchio, CFA, portfolio manager of Ranger Alternative Management and AdvisorShares Ranger Equity Bear ETF (HDGE)

 
As a short selling portfolio manager, we constantly monitor market relationships for positive or negative divergences in the broad equity market indexes. One of the most important relationships is that between price and volume. In a bullish scenario, one would want to see volume expand as price rises. This typically means that large institutions are increasing their bets to equity markets as indexes and individual stocks strengthen and prices are rising. Conversely, rising prices coupled with weak volume expansion often indicates that shares are being transferred from strong institutions to weak retail investors.

The chart below, which illustrates the relationship between the index value of the S&P 500 and the volume of all equities, is an important indicator to measure the strength of the market, especially considering we are near all-time nominal highs.

Notice that in the early 1980’s, the index bottomed out and began a large secular bull run. In fact, one of the largest in modern history. During that time period, volume expanded as the markets vaulted higher, with a very strong correlation between the two.

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Then, as markets topped out in 2007, so did the volume. The great crisis of 2008-09 was underway, and the volume in the market was at record levels as investors all ran for the exit signs at once. However, as the market bottomed in 2009 and started a cyclical bull market, a massive bearish divergence formed. On the far right hand side of the chart, the indexes have marched toward all-time highs, but the volume is only about as much as 2006. Thus, we are seeing less buying power fuel the markets higher.

We find this relationship worrisome because the demand for stocks is tepid at best. Over the past couple of years, when there have been meaningful pullbacks in the market, it has been met with much higher volume than the subsequent rallies. This lack of conviction in buying equities sets the market up for greater volatility and downside performance as everyone once again races toward the exit door at the first sign of trouble. Couple this with fewer short sellers participating in the markets given the huge rally over the last five years, and there’s even fewer market participants available to buy stock as prices fall and provide stability to financial markets. This too will exacerbate the downside. So, while the level of bullish advisors may have been excessive to the number of bears at the most recent high, it hasn’t been met with corresponding volume. Thus people may be saying one thing (“markets are going higher”) while doing something else (selling aggressively into declines). Buyer beware.

david@mediaworksllc.com

The AlphaBaskets blog provides frequent market insight and commentary by AdvisorShares Investments, LLC, created by AdvisorShares and other leading active managers.  AdvisorShares Investments is an SEC-registered investment adviser and the investment adviser to the AdvisorShares actively managed ETFs. The views expressed on AlphaBaskets should not be taken as investment advice or a recommendation for any of the actively managed ETFs advised by AdvisorShares.

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