There's Some Very Weird Things Going On In the Market

Fundamentals no longer drives the stock markets. The market has been rising, but earnings have been falling. See the table to the right.

Let’s begin by acknowledging that the average bear market rally rises 33% - - and the current market rally is up 25% on the Dow, 29% on the S&P, and 31% on the NASDAQ. So this one-month rally should not be viewed as anything special; it just feels that way because it has been a long time since we seen a decent market rise.

Another thing to notice is the market has been setting extreme positions on many technical indicators for the past couple weeks. Regarding stock advance/declines, we've had extreme readings 6 times within the last 16 trading days. Normally, we get one such extreme reading after a new bull market has started. The last time there was an extreme reading happened was two months after the market retested its lows in 2003. But the market have been mostly moving sideways for the past couple weeks with the S&P only now touching 855, a key channel resistance. The Dow and the NASDAQ have also experienced a similar situation. All of these stock advances have produced little in the way of overall market movement.

Let’s look at who comprises the market. The stock market can also be broken down into three groups of traders; i.e., the large financial institutions like the major banks, then the hedge funds/pension funds/insurance funds, and then the small traders. The financial institutions control the stock market. The point is, it pays to trade with those groups that have a track record of success and bet against those with a losing record. And to put it more succinctly, the small traders are always wrong.

So where are we going from here? Will the markets break through resistance and rally higher, or will it bounce off and go lower?

We must consider the fact that about 80% of all trade volume on US markets is algorithmic with the remaining 20% to contain most all of the small traders. So of these 80%, who are the primary traders?

As the graph to the right shows, 32.6% of all trading is done by a handful of financial institutions.







The Zero Hedge blog provides some insights into these companies as the graph to the rights shows. As quoted from his web site:

Key to note here is that Goldman's program trading principal to agency+customer facilitation ratio is a staggering 5x, which is multiples higher than both the second most active program trader and the average ratio of the NYSE, both at or below 1x. The implication is that Goldman Sachs, due to its preeminent position not only as one of the world's largest broker/dealers (pardon, Bank Holding Companies), but also as being on the top of the high-frequency trading/liquidity provision "food chain", trades much more often for its own (principal) benefit, likely in tandem with the other top dogs on the list: RenTec, Highbridge (JP Morgan), and GETCO. In this light, the program trading spike over the past week could be perceived as much more sinister. For conspiracy lovers, long searching for any circumstantial evidence to catch the mysterious "Plunge Protection Team" in action, you should look no further than this.

Following on the circumstantial evidence track, the Volume Weighted Average Price (VWAP) of the SPY index indicates that the bulk of the upswing has been done through low volume buying on the margin and from overnight gaps in after hours market trading. The VWAP of the SPY through yesterday indicated that the real price of the S&P 500 would be roughly 60 points lower, or about 782 (not 856), if the low volume marginal transactions had been netted out. And yet the market keeps on rising. This is an additional data point demonstrating that the equity market has reached a point where the transactions on the margin are all that matter as the core volume/liquidity providers slowly disappear one by one through ongoing deleveraging.

So Goldman Sachs is by and away the market maker and is also the primary proxy used by the Treasury’s “Plunge Protection Team” (PPT). More interestingly, the latest market rally has been strongly based on the low volume overnight trades in the futures market rather than intraday market moves itself. This is significant change in method of operation. This might be the prime reason for the currently lower intraday volume, and what appears to be institutional abandonment of index ETFs like DIA/SPY/Qs. It can only be surmized Goldman Sachs can get more bang for the buck with the use of the overnight futures market.

A random sampling of 2008 program trading volume statistics found no instances in which Goldman Sachs accounted for more than about 15% of the weekly program trading volume. That said, for two of the past three weeks of the current rally, Goldman Sachs % of program trading market spiked to over 26%. This is abnormal.

Could it be the PPT is spending more money to prop up the market? Or is it due to the fact Goldman Sachs will be raising $10 billion with a stock offering on Monday to pay back TARP. They do need a high stock price for their offering. This was a big reason for Wells Fargo’s Thursday earnings announcement coming two weeks ahead of time, which helped to provide cover for a GS stock rise.

All of this is significant because as the financial stocks go, so goes the market. We cannot have a sustained rally without the financials going higher. So, we'll continue to monitor the fnancials closely for any hints of a market turn-around.

How long GS will keep the market propped up after their stock offering is completed will be determined by the put-call ratios (market sentiment), the volatility index (VIX), and the potential for making money with a bull or bear squeeze. We are going into options expiration next Friday. But we need to keep in mind that any bank not reporting on par with the Thursday Wells Fargo earnings pre-announcement could tank the market since our expectations are set much higher now, and major bank earnings annoucements will be coming out during the next couple weeks.

To be continued: