Global markets have suddenly rediscovered risk.
After marching steadily higher for three months, stocks in Canada, the U.S. and Europe are running into a growing wall of worries. Concerns over slowing growth in China, a possible recession in Europe and Greece's looming deadline for a debt swap are just some of the factors that have clobbered the market in recent sessions.
Even as stocks were soaring ahead of this week's pullback, there were hints the rally was built on shaky foundations. Low trading volume and a lack of buying by company insiders signalled the market's advance was vulnerable to the reality of a slowing global economy and persistent government debt problems. Another worrisome sign was the outflow of money from mutual funds that invest primarily in stocks.
In their worst plunge this year, the Dow Jones industrial average fell 204 points to 12,759 on Tuesday while the S&P/TSX composite index sagged 225 points to 12,299. Markets in Europe and Asia also closed lower, while the prices of safe government bonds rallied.
In a recent note to clients, Pierre Lapointe, global macro strategist at the brokerage firm Brockhouse Cooper in Montreal, says investors yanked a net $23.5-billion (U.S.) out of U.S. equity funds over the past six months, indicating that many Main Street buyers remain skeptical of stocks' potential for further advances.
Mr. Lapointe says the fuel for rising share prices has largely come from mutual funds deploying their idle cash balances, rather than from new money pouring into the funds. The proportion of cash in funds fell from 4.2 per cent last April to only 2.6 per cent in January. "The problem is that cash assets in mutual funds are now near a 22-year low. This means that, going forward, it will not be as a potent catalyst for equities," he wrote.
A high amount of insider selling – stock sales by senior executives and corporate directors – also indicates skepticism about the market's recent advance. These well-placed investors, who presumably know a great deal about their firms and the economy, have been steadily divesting themselves of shares. There were more than thirteen dollars of insider sales for every dollar of insider buying in February, the highest level in four months, according to a compilation by TrimTabs Investment Research.
Even as stocks have gone up, trading volume has fallen. Average New York Stock Exchange trading was well over 2.5 billion shares a day in 2008. So far this year, it's only about 1.3 billion.
Market watchers have traditionally assumed that share prices and volumes should rise in tandem to put a rally on a strong footing. By that measure, the lack of trading is reason to worry.
However, some observers contend that trading volume is being distorted by such factors as a decline in banks trading for their own accounts. Falling volume "has not been an impediment [for the doubling of stock prices]since March of '09," says Jeffrey Rubin, director of research at Birinyi Associates Inc., who plays down the impact of decreased activity
In a report to clients earlier this month, Birinyi predicted that the bull market was alive and well and that the S&P 500 was set to rise to 1,700 from around 1,343. The current selloff is "just a correction," Mr. Rubin says. "Every year we have four or five per cent corrections, at least."
Ron Meisels, technical analyst at Phases & Cycles Inc., a Montreal-based stock advisory firm, said the market rally was ready for a pause. "The market was overbought and it was very extended," he says.
Mr. Meisels says it is common for corrections to wipe out about a third of a market's preceding advance. By that measure, the Dow could fall further to about 12,250 to 12,500, while the S&P TSX could drop to about 12,200, he says.
"After a good January and a good February, a bit of profit taking won't hurt," he says.