You can always find bullish signs and bearish signs in the market. Currently, small- and mid-cap price indices provide signs of strength, while trading volume gives a bearish outlook.
You know a bull trend is in full force when smaller-cap stocks are rising by more than large-caps. That is happening now in both the Canadian and U.S. stock markets, although the indication is clearest on Wall Street.
Volume trends look further out. “Volume precedes price” is an axiom made familiar by market analyst Joseph E. Granville, who is famous for being both spectacularly right and spectacularly wrong about the market outlook. His big contribution to market analysis regards emphasizing the importance of market volume.
A rising amount of stock trading is bullish. The entire bull market from 1974 to 2000 was preceded and accompanied by rising share trading volumes. Volume continued to rise in the post-2000 rally.
But since mid-2010 on Wall Street and mid-2009 on Bay Street, trading volume has been dropping. This is despite the addition of “dark pools” and high-speed computer trading to the markets.
The comparisons are stark: on the Toronto Stock Exchange, 21-week average volume has dropped to a recent low of 1.4 billion shares from 2.5 billion shares in mid-2009. And the New York Stock Exchange’s six-month average trading volume has dropped to 22.4 billion shares from 41.3 billion shares in mid-2010. No wonder brokerage firms are losing money.
The implication is not good: unless the current rally produces a prolonged and huge rise in trading activity (see chart, right), a bullish price outlook may be erroneous.
Now, for the bullish view: in bull markets, small-cap stocks always produce bigger profits than large-caps. On Wall Street, the smaller stocks are at full throttle, judging by the performance of S&P 600 index (small-cap) and the S&P 400 index (mid-cap).
Although small-cap stocks normally lead, the mid-caps have been stronger recently in the U.S. Since their May 2012 weekly lows, the S&P mid-cap index has risen by 23%, edging out the small-cap index’s 22.7% gain. The large-cap S&P 500 composite index, in comparison, has gained 18.4%.
Since monthly lows in November, the mid-caps have risen by 29.2% vs a 16.5% gain by the small-cap index and a 7.9% rise by the S&P 500 index.
In Canada, the gains by comparable indices are smaller. One significant change has occurred since the market hit a low in November: the S&P/TSX small-cap index has been the leader on the upside, besting the mid-caps’ S&P/TSX completion index.
Mid-cap stocks have led in Canada since the 2009 low. The completion index has risen by 102% since then, vs 59.7% for the large-cap S&P/TSX 60 index and 91.1% for the small-cap index.
The small-cap index has been the best gainer in Canada since the monthly low in December, rising by 4.9% vs rises of 3.9% by the completion index and 3.7% by the S&P/TSX 60 index.
From the monthly low in November, the small-cap index has risen by 7.3%, which was bested by the S&P/TSX 60 index’s 8% gain. The completion index rose by 6.7% in the same period.
The market’s moves from recent lows – both November’s and the “fiscal cliff” drop in December – reveal changes in growth among Canadian indices.
Should the small-cap index keep rising by more than the other indices, the case for a continuing bull market will grow stronger.
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