Thursday, December 10, 2009

Some trading slack still left

Technical analysts like to look backwards. They look at chart patterns earnestly – hoping to decode the signs of change in a price level. Looking back to predict the future is the modus operandi of the market technician. Some like to say that “this time things are different”, that the forces acting on the market today are far different from the forces that moved the market decades ago. Most often, though, history proves to be a sage advisor. In truth, the market is evolving – like the world it reflects – and there are new and complicating variables that make it difficult, maybe impossible, for even the most revered oracle to see clearly through the fog. One changed factor that has made a difference in the markets is the tremendous expansion of capital and trading. Compared to the liquidity of today, the markets of a generation ago were homespun, almost quaint.

The total market capitalization of the Toronto Stock Exchange – itself just a tiny component of a vastly grown global equity market – has increased from about $100-billion in the mid-1960s to over $1.7-trillion currently. But the size of the market, both locally and globally, implies a new variable only in so much as that growth in capital corresponds to an increasing propensity to trade. Trading is what creates price changes in securities. It is the force of change on valuations – and it expands market volatility. More trading demands better information, better pricing discipline, and more efficient markets.

Given the latest market meltdown that last statement may have you in stitches – we seem to move from one bubble to the next. However, trading expansion is undeniable and consequential to the movement of prices. On the TSX average daily trading volume is up almost 678% in the last 15-years. But average daily transactions are up over 3,179%! Clearly, a new type of investor has come to the fore. From a growing number of actively managed accounts under the wing of institutional portfolio advisors to the small retail investor trading from home computers, there is a tremendous force of energy fuelling stock price movements. The character of that trading shows that market timing activity – a heightened intensity of trading – in the plummeting average traded value in recent decades. Average traded value on the TSX was about $50,000 fifteen years ago – now it’s one-fifth that level.

The market downturn last year stalled out the growth in transactions. Looking back to the market bust of 2000 the TSX showed a similar decline and plateau of transactions. Not until five years later, did the number of weekly trades begin a new trajectory. Notably, the current market rally that has added 50% to the S&P/TSX Composite Index has been accompanied by diminished average weekly transactions. At the March market low the TSX recorded about 4.4-million weekly trades. Average weekly transactions over the last three months numbered only 3.7-million – a drop of 17%. Average weekly volume of shares traded, however, is only 4% below the March price level low. And although shares are transacting at a better rate now than when the S&P/TSX Composite Index peaked in Q2 of 2008 (up 20%), that growth is less than the growth of the volume of shares traded (up 23%).

What does the slipping transaction growth rate in the current rally suggest? Perhaps it is telling us that that despite worries that the market is overextended, the retail investor has not yet arrived at the party. There may be more room for either a continued uptrend or at least a flattening of the market trend as opposed to a severe pullback in the coming quarters. A rapid increase in the number of transactions is concurrent with a selloff, to be sure, but it can also occur in advance of that selloff – at a market price level peak. In recent market price level peaks the rate of transaction growth was significantly higher than the rate of volume of shares growth. Although this is consistent with the long-term trend described already, the current market conditions seem to offer relatively favourable support of a bullish outlook.

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