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Traders work on the floor of the New York Stock Exchange (Spencer Platt/AFP/Getty Images)
Traders work on the floor of the New York Stock Exchange (Spencer Platt/AFP/Getty Images)

Market lab

Trading volume trend signals a market that's lost its way Add to ...

What if the stock market rallied, and nobody came?

That, argues Merrill Lynch’s Mary Ann Bartels, is exactly what happened as the U.S. stock market rebounded this month from its rough September. Beneath every rallying session was a disturbing lack of investor fuel. In that light, this week’s return of the market’s directionless stumbles really wasn’t that surprising; The rally, with little to back it up, never had a chance.

Big gains, small volume

Ms. Bartels, Merrill’s head of technical analysis, said in a report this week that the New York Stock Exchange has shown a consistently disturbing habit: On big upturns, trading volume sags precipitously, but when the market tumbles, it’s routinely on big volume.

She said this pattern is evident all the way back to early August, but was particularly striking in the rebound in the first two weeks of this month. The S&P 500 gained in seven of nine sessions, rising 11 per cent from its Oct. 3 low – yet volume fell sharply, and almost daily, throughout that run. On Friday, Oct. 14, when the S&P 500 reached a 10-week high, the trading volume on the New York Stock Exchange was at its lowest in the entire 10 weeks – and nearly 30 per cent lower than the average daily volume during September’s market slide.

“This suggests the investors are fearful at the lows and not buying into the rallies to the highs,” Ms. Bartels wrote. “This does not support the case for a sustained move higher.”

A short squeeze?

So if investors weren’t jumping on board the market rally, what did provide the fuel? Short-covering.

Ms. Bartels said the 100 most-shorted stocks on the New York Stock Exchange gained nearly 14 per cent from the Oct. 3 low to the Oct. 14 close. That vastly outperformed the overall New York Stock Exchange, which was up 9 per cent.

“This suggests a short squeeze,” she said. “This risk is that real buyers remain absent from this rally.”

A quick look at the Canadian numbers, though, suggests short-covering has been a much less dramatic driver this month on the Toronto Stock Exchange. The 20 most-shorted stocks on the TSX rose, on average, 10 per cent from the Oct. 4 low to the Oct. 14 high – topping the 8.1 per cent rise in the S&P/TSX composite index over that time.

But those average returns for the most-shorted stocks were heavily skewed by one relatively small stock – Bankers Petroleum Ltd. – that surged 34 per cent during the period. If that stock is removed, the average gains for the most-shorted stocks was 8.7 per cent. This implies that while short-covering may have been a major driver in the U.S. market’s early-October rebound, it played only a modest role in Canada’s gains.

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