Quietly, the stock market climbs higher.
We say quietly because something has been missing – volume. This week’s relentless climb for the S&P 500 has been on volume ranging from 70-80% of long-term average trading activity.
Remember that the price of a stock is set by the last price at which it traded. A single trade at the end of a day establishes the price for every share of the company held across the world. While the price of a share should reflect fundamental earnings power over longer periods of time, on any given day it is a product of how aggressive buyers are versus sellers given known information. It is commonly believed that a higher trading volume implies that more people have opinions and thus the price produced by their trading has more informational value (the “wisdom of masses”). Lower volume bring s lower confidence that the price means anything at all.
Of course, these days most of the trading on stock exchanges is computer-driven. The percentage of daily trading volume based on computer algorithms has steadily climbed since the early 2000s to an estimated 70-80% as recently as last year (coincidentally). It is unknown how much of this week’s trading volume is computer driven (and certainly not all), but it may be a factor contributing to the climb higher. Computer-trading tends to be trend-following, that is to say that the computer is more likely to buy a stock if the last trade ticked up. An upward trend begets a further upward trend.
It also fits with the fact that the NASDAQ Composite index reached its beginning-year level this week bringing its return to near zero for the year. This is despite the fact that the average return of a stock within the NASDAQ Composite index is still down 13% for the year. How is this possible? Concentration. While much has been made of the S&P 500’s concentration (top ten holdings are roughly 26% of the index), the NASDAQ has 44% in its top ten. The top 3 (Microsoft, Apple, Amazon) represent over 28%! It is not a surprise to any market-watcher that these companies have been on the trend higher for some time.
Something else happened quietly this week. Trading in futures on the Federal Funds rate indicated that some market participants believe rates will go negative next year. That contradicts all of the communication by Fed policy makers on the topic over time and should be taken in the context of a lightly-traded market. Regardless, it is consistent with the observation that rates across the yield curve remain low. The two-year US Treasury yield hit a historic low of 0.10% on Friday after the Labor Department’s report on employment before rebounding a bit to end the day at 0.16%. We have talked about our view that investors are likely to re-set equity valuations higher eventually based on lingering low rates, but expect it to occur after the virus is deemed on a path to containment. Perhaps as traders toss out this year’s earnings estimates to look out to 2021/2022, they are also applying a post-pandemic price multiple based Treasury rates remaining at these levels.
While we are encouraged at the stability of daily case counts in the US and progress being made on treatments, it is still too early to say the health risks (and its economic consequences) are clearly receding.
If traders jump the gun, the stock market could make some noise.
Will Skeean, CFA
Partner – Investment Management Team Chair