Dow Hits 17-Month High, but Is the Rally Running on Fumes?

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Stocks charged higher Tuesday, helped by strong earnings and outlooks from cruise operator Carnival Corp. (CCL) and Bank of China (BACHY), the nation's third-largest lender. Unfortunately for the bulls, the major averages rose yet again in a technically bearish way. Volume, the so-called weapon of the bull, continues to run low, raising the question: Is this rally running out of buyers?

The blue-chip Dow Jones Industrial Average ($INDU) rose 103 points, or 1% to 10,889, while the broader S&P 500 ($INX) gained eight points, or 0.7%, to 1,174. The tech-heavy Nasdaq Composite ($COMPX) added 20 points, or 0.8%, to finish at 2,415.

That's all well and good, of course. The Dow, sitting at a new 17-month high, is now up more than 4% on the year. The bad news is that volume, or the number of shares changing hands, has been trending down since the craziest days of 2009. Barely a billion shares traded on the New York Stock Exchange Tuesday, while relative volume, which measures current volume as a percentage of an average session, came in at just about 80% on the Dow -- despite it tacking on a triple-digit gain.

Volume Means Conviction

What's the big deal about volume? Technical analysis focuses on two things: price and volume. Volume measures the conviction of the marketplace, and what low volume means is that small investors are still sitting on the sidelines. With more than $3 trillion dollars parked in money market mutual funds, equity mutual fund managers have record low levels of cash with which to buy stocks.

Meanwhile, a record $360 billion flew into bond mutual funds last year -- more cash than in the previous five years combined -- and it hasn't budged. In other words, the stocks may have rallied 70% over the past year, but individual investors still want no part of them. Heck, even Ed Yardeni, the bullishly prescient president of Yardeni Research, told clients that bearish technicians are warning that the stock market rally has been running on fumes because of low volume.

That could help set the market up for a serious pullback in the shorter term, Jeffrey Kleintop, chief market strategist at LPL Financial, warned clients this week. "Another stock market pullback of 5% to 10% unfolding over a few weeks would not be unusual," Kleintop writes. "There are a few reasons to question the health of the recent rally. Some technical indicators suggest the stock market is now overbought and recent gains have been on light trading volume, suggesting the buyers are becoming fewer."

John Hussman, manager of the well-regarded funds bearing his name, told shareholders this week that the technicals strongly suggest playing defense. Sure, the market could trend higher in the short term, writes Hussman, but it is rarely rewarding to chase such advances. "Prices typically retreat to the same or lower levels a few months later (and in some cases, can remain below those levels years later)," Hussman says.
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