Internal Strength of Market

The rally since the summer lows has been driven by several factors: 

1) Fast money rotation away from energy and materials, and into high beta names like tech and in particular semiconductors;

2) An excess of cash sloshing around chasing performance;

3) A dearth of new issues and decreasing share count, fostered in part by record-setting stock buybacks.

A rally can progress over the short term, with increasingly poor internals, due to these other factors. Eventually, however, the  market’s internal health catches up with it, and the inevitable correction occurs.

John Hussman has reviewed some of the recent internals, and he gets this precisely correct: The slowing economy will eventually pressure corporate revs and profits, and the enthusiasm for the present race towards the May highs will be replaced with something, well, less enthusiastic:

"Wall Street analysts and business reporters remain enthusiastic about the idea that a slowing economy will slow inflation, that profit margins will remain high (despite evidence of rising wage pressures) and that a Federal Reserve “on hold” will translate to higher valuations. Last week’s inflation data was clearly hostile on import prices (+0.8%) and export prices (+0.4%), but “in-line” for the CPI (+0.2%). No positive surprises, but the benign CPI number did buy some time for the “Goldilocks” crowd. Until the data counter the “inflation has turned” thesis (which I expect, but our investment stance does not require), we have to allow for the possibility that investors might speculate on hopes of a “soft landing.”

No tmuch to disagree with there.

 Here’s the graphic depiction (as of 9/18/06):

Advancing / Declining Volume (A/D Line)
click for larger chart


Common Stocks vs All NYSE (Bond funds, ADRs, etc.)
click for larger chart


Consider the NYSE volume — hardly impressive:

NYSE (6 months)
click for larger chart


A combination of unfavorable valuations, unfavorable market internals, and weakening overall economic trends does not typically bode well for the near future . . .


A House Built on Sand
John P. Hussman, Ph.D.
September 18, 2006

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What's been said:

Discussions found on the web:
  1. lurker commented on Sep 22

    Bond market sure looks like it is anticipating a hard landing. Hey Barry, I thought hard landing and recession were the same thing. Were you busting our chops?

  2. Barry Ritholtz commented on Sep 22

    Here’s my unofficial hierarchy:

    soft landing

    hard landing



  3. Sean commented on Sep 22


    Your Favorite Links list is quite overwhelming.

    Who other than Hussman would you add to your All-star roster?

  4. BDG123 commented on Sep 22

    Really like the NYSE AD chart of common versus “other”. I find the NYSE on the surface extremely misleading any more. There’s so much garbage including bonds trading as stocks which make the surface numbers appear misleading. Bonds and preferreds and other goofy instruments are rallying because bonds are rallying. That makes the AD line appear positive when a rallying bond market here is not a healthy sign for stocks. The underlying market tone is unhealthy.

  5. Michael C. commented on Sep 22

    No doubt internal strength has sucked on a daily chart for the last few years. And if you use a monthly chart, internal strength has arguably sucked since the bull market ended 6+ years ago.

    I said this right before the Fed announcement:

    “It’s now almost fully priced in a no rate hike scenario. So any new money, if at all, flowing into equities on the non-news Fed will be just money that was waiting as an excuse to buy.

    I suspect after the fast exhaustion of new money (and the remaining short covering) there will be an air pocket of sellers with the mindset of “why are we holding and not selling?” and buyers thinking “what now?”

    But now for the short term since the market has had a good reaction to the Philly Fed Index, I’m wondering if it was a short term low since gas prices have ticked down and mortgage/refinance apps are at a high for the year. Or is the Philly Fed a glimpse of things to come?

    I’m going to look for the answers in guidance from upcoming earnings reports and conference calls. I think the reaction to the conference calls will be a good tell for the market to the end of the year.

  6. ee commented on Sep 22

    Sovereign Spread up 34bps in 5 weeks
    tells us something

  7. Mark commented on Sep 22

    I see the 3pm Buy Program is working….

  8. OldVet commented on Sep 22

    I can see some enthusiasm for a Fed on hold at 1%, but at 5% you’re really betting on rate cuts rather than on 5% . That’s a speculative position since inflation appears higher than Fed likes it to be, and import prices are slowly rising for a change.

  9. john commented on Sep 22

    The bond yields across the board have really been tanking– the bond market (and I guess along with the help of the FED) is anticipating a sharply slowing economy. With both interest rates and oil on a sharp decline what size of monetary affect will this have on the lower to middle class consumers, especially those that need to refi out of those “specialty” ARMS. The last couple of years the stock market has risen (in my view ‘Miraculously’) in the face of higher oil and higher interest rates. Now we have oil falling off a cliff (although I expect a sharp snap back rally at some point– the “Iran Issue” will not go away anytime soon) and interest rates going into the toilet as well– we do not have quite the bubble in the stock market we did in 2000– and the FED seems determined to avoid a repeat of the 2000-2002 crash. So I’m wondering, if the stock market isn’t winding itself up here with these pullbacks to push onto all time highs. I think a lot will depend upon the markets perception of what the FED will do to avoid a repeat of the 00-02 crash performance and to give us a “soft landing”.
    All of that said however I would like to see the “fast money” (and speculative money) get blown right out of this market with a Heavy Correction. As Barry (and others — like Tim Wood) have said the market internals have looked lousy for some time now. And at least according to one of the articles linked here (Martin Weiss at SafeHaven) and my own view these Rosy Headline Economic Numbers spoon fed to the Financial Media outlets from the FED Govt continue to have their Fuzzy Math applied to them.

  10. tjofpa commented on Sep 22

    Will the FED be able to cut rates if the $ index starts breaking towards 80?

    Is the Trade-Weighted $ index still making new lows?

    …and then we see this little diddy;

    The Senate is likely to pass within the next week a measure to put tariffs on imports from China in retaliation for that country’s currency policies, Republican Charles Grassley said today.

  11. muckdog commented on Sep 22

    Don’t think we’re going to get the bear scenario just yet, BR. I think the stock market is pricing in the soft landing. Speculative money is coming out of oil, metals and commodities, and will be put to work somewhere. As it becomes obvious that the economy keeps trucking, I think that money will be put into the market.

    That being said, I think the planetary prediction of a Sept-Oct will get some self-fulfilling action over the next week or so but that’ll give that speculative money a shot at being deployed. And it will…

  12. Mark commented on Sep 22


    “As it becomes obvious that the economy keeps trucking, I think that money will be put into the market.”


  13. whipsaw commented on Sep 22

    My personal view is that many of the things that BR, Roubini, etc., have been talking about for quite a while are evolving (albeit with some twists, as always) and it ‘s all a matter of time horizons. I do think that there will be another push up between now and November via some election-related manipulation on a grand scale that could possibly result in a New High! for the Dow. Perhaps the September FOMC minutes will indicate that they are expecting to cut rates or maybe the October statement will suggest the same and off we’ll go, at least until the players face up to why rate cuts are going to be necessary to begin with.

    In anticipation, I find myself with 85 cheap OTM November calls in DIA and QQQQ which is more contracts than I’ve ever owned at one time. But my sentiment is that shortly before those expire and after I have dumped them, it will become okay for the MSM to discover that the economy is seriously broken and that we’ve on the Highway to Hell for 6-12 months. That’s where March SPY puts come in, as BR may get most of his expected market collapse by then.

    I will acknowledge that given a “do-over,” I probably would not be in the equities market at all right now, but in July I re-bought the SPY puts that I’d already sold twice for handsome profits and have had to put a remedial plan into action since then. But I think that getting smacked around on paper is good for you if you learn anything from it and, more importantly, if you are 90% cash and bonds anyway.

  14. DavidB commented on Sep 23

    Except for a nice rally in my bond funds my stocks have started churning over the last week. That includes high volatility and low volatility stocks so I am assuming people are beginning to take a wait and see approach as they seriously begin to data mine for any significant clues as to where the economy is headed.

    Oil and the fed are positive for the numbers. They are opposed by housing, consumer credit and world CB(specifically Japanese) money contraction on the other

    Wait and see is the key catch phrase as we begin to settle in to how Bernanke steers a course

  15. tjofpa commented on Sep 23

    Doug Noland interview over on FinancialSense…
    I highly recommend.
    Amazing stuff from 2 big bears. They see no current slow down in Mtg Finance.

  16. marc faber commented on Sep 23

    Marc Faber, better known by his self-appointed nickname “Dr Doom,” has temporarily shed his preference for emerging-market stocks for two out-of-favor asset classes: large-cap U.S. industrial and technology shares
    The main reason for his upbeat view: the U.S. consumer may be more resilient in the face of a slowing U.S. housing market than widely thought.
    While housing prices may be easing around the country, Faber says there’s little evidence a catastrophic drop in home values is imminent. Abundant liquidity and a Bernanke-led Federal Reserve that appears inclined to cut interest rates if the housing market were to dip more than 10% bodes for “a slowing and not a collapse” in the housing market, says Faber

  17. whipsaw commented on Sep 23

    Well Marc, I would agree with you that it’s time to forget about submerging markets, but I’d walk real slow on getting into tech, large cap or otherwise. Aside from being mostly crappy companies that don’t pay dividends and have a rather casual attitude towards things like option grant dates, tech is not going to be going anywhere for the next year or so.

    I say that because I work for a rather large tech company and, altho we are doing okay, I am picking up on a certain amount of anxiety from the sales guys that I haven’t seen since 2002. Usually, when I run across them, everything is Great!, but now it’s “kind of frustrating” which in hustler-speak means that they are not closing deals that they have been working on for 6-12 months.

    I also note that the listing count for the Atlanta section of has dropped by around 100 since I last checked it in July which is when it would have been seasonally low anyway. For some perspective, it is currently 2895, was around 7,000 the last time I was in the market in mid-2000, and was around 950 or so at the bottom of the dotcom crash.

    I don’t bother to check the other cities that covers, but it’s most of the tech centers and they are most likely down as well. This is a pretty specialized listing service that is taken seriously and the listing counts have been a pretty good pointer to what’s actually going to be happening in tech over the next year. If the listings are dropping now, most people would say that going into tech stocks is an extremely bad idea.

  18. Brian commented on Sep 23

    Aha, Marc, capitulating bears. Another piece of the puzzle.

    Didn’t Steven Roach go bullish in May right before the dump?

  19. Andrew commented on Sep 24

    whipsaw – Being a former IT guy myself I often watch the computerjobs site but I haven’t found the same corrolation as yourself. In fact, over the past year I’ve noticed an upward trend in total jobs listed there. I think this trend should continue. Companies have record cash on their balance sheets and it seems like the only thing they can do is buy-back stock. I think over the next year we’ll see these companies increasing spending on things they consider profitable. IT is a big one. If a true recession really hits and businesses start letting staff go they will have to replace the missing roles with something. This is usually done by outsourcing work and information technology is a huge focus during these times. I expect companies like IBM and Cognizant to beat estimates during this time. Computer services in general. Still not too sure about the hardware/semi side of things. As I said I used to be an IT guy. I remember the days when hardware upgrades were MANDATORY for even minor software upgrades. But with the power in todays PCs I don’t think this is still necessarily the case. Business today can far more easily upgrade the software side without much hardware hassel. BTW I’m not saying computer hardware in now useless, just that the software side has some catching up to do effectively use (waste) todays resources.

    Anyway, point is that I expect these companies with huge cash piles to plow it into tech spending. But the real question is “What kind of tech?”. I’m guessing the service side. Besides tech, I see a good future for many outsourcing companies that can control their costs. ADP comes to mind.

  20. Andrew commented on Sep 24

    Sorry, forgot to add this caveat to my above post: Just because I’ve noticed an upward trend in postings to doesn’t mean that more jobs are available. It could simply be that the site is becoming more popular.

  21. ee commented on Sep 24

    another sign of market weakness :
    Last week , about a third of all ETFs made 6 week highs and closed below the week’s open

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