Are New Highs on Lower Volume Bullish?

What a difference four years makes! After bottoming in March 2009 at 666 - that devilish number - the S&P 500 (NYSEARCA:IVV) today crossed above its previous all-time high of 1,565 (reached on Oct 9, 2007) to close at 1,568. Thank you Ben BernanQE!

But new market highs are coming on lower trading volume. Is it a problem?

Data from the NYSE Euronext shows a year-over-year -12% drop in handled volume for NYSE stocks, -15.6% for NYSE Arca, -16.2% for Nasdaq listings, and -13.8% for exchange-traded products (ETPs). (See chart below)

Since the 2008 financial crisis, market volume for U.S. stocks on all exchanges has declined by almost half. This is a very different environment from previous down cycles in 1987 and again in 2001, when the appetite for investing/trading in stocks rebounded within a short period.

Then, something happened after the Flash Crash in 2010. The stock market kept rising even though total capital dried up. And by drying up it we mean volume shrank faster than prices rose. What about now?

Since the short-lived selloff that took stocks down 20% in mid-2011, total capital has again dried up. Based upon ETFguide's Total Capital Traded (TCT) Indicator, we've approached late 1990's levels at under $10 billion per day.

With average daily TCT back below $10 billion it is clear the market's rally since 2010 is abnormal and not built on normal supply and demand metrics.

Today, low NYSE trading volume has been offset by corporate mergers and share buybacks (NYSEARCA:PKW) but the sustainability of this activity can only keep the rally alive for so long.

Keep the following in mind:

1) Rising volume on rising prices (NYSEARCA:SPY) is normal whereas rising prices on falling volume is not;

2) Volume normally leads price (SNP:^GSPC) during a bull move. A new high price (NYSEARCA:IWM) that is not confirmed by volume should be regarded as a red flag;

3) Rising prices (NYSEARCA:DIA) and falling volume are abnormal and indicate a weak and suspect rally.

Also, the length of this particular rally has been unusually long. The average historical duration for cyclical bull markets within a secular bear is only 3.1 years and only two other time periods over the last 100 years have hadlonger rallies than the current one.

What will be the final sign stocks have topped?

The April 2013 issue of ETF Profit Strategy Newsletter examines the breadth and length of the S&P 500's four-year rally versus history. Also included is our 2013 ranking of top commission free ETF brokers along with a short, mid, and long-term outlook for stocks, bonds, and gold.

Watch our ETF Video at YouTube titled "What Volume is Saying about the Market."

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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