Occasionally, we can learn something profound about the nature of rallies by looking at market internals. When combined with other data, this is often revealing. Amongst other things, we may deduce the disposition of large fund equity traders, and whether they are likely to persist in their present behavior of buying or selling.
In particular, it’s possible to garner insight into the behavior of institutional fund managers. Their actions are significant: these large players are responsible for about 75% of the exchange volumes. Its been estimated that the 50 largest funds are responsible for half of all institutional trading. Whatever acuity we may have into the mindset of the professional money manager, it may reveal clues into their future behavior (if only for the short-term). Even the pros can tend towards “herd think” on occasion. The key question is, “are they buyers, sellers or mere spectators?”
A defining characteristic of the rally has been its excellent breadth. This is primarily seen in the advance/decline line, but also revealed through strong up/down volume. Starting mid-January, the character of the rally began changing. Overall volume started falling. By February, the tenor of the markets was notably different than it had been prior.
Consider the following two apparently unrelated metrics: mutual fund inflows, and up/down volume. Both of these have changed conspicuously since late January – not coincidentally when the Nasdaq made its short-term peak. Mutual fund inflows were about $17.5 Billion dollars in December 2003. That inflow spiked to $40.8 Billion dollars during January. Based upon weekly data, fund inflows are back to the sub $20 billion levels for February.
During this same period of weakening inflows, we have also observed a decrease in the day-to-day overall volume – especially on the Nasdaq. In early January, Nasdaq volume was ~1.2 to 1.4 Billion shares daily. That has weakened by 30% to around billion shares a day. This falloff in volume is acutely occurring within the Up Volume.
This suggests to us that Fund managers have gone on a Nasdaq “Buyer’s Strike.” Lighter fund inflows have forced managers to be more selective buyers, steering away from pricey tech stocks, to the benefit of higher quality issues. The new preference is for more profitable, lower P/E, dividend-yielding companies.This change reflects a maturing of the rally, perhaps into something more sustainable over the long run.
We expect the institutions to stay Nasdaq spectators for the immediate future.
This lack of buying, rather than aggressive selling, suggests that this correction is merely that: A short-term interruption within a longer rally. As such, we expect the Nasdaq to find support levels at 2000 and 1860; the SPX at 1125/1070; and the Dow at 10,450 and 9,870.