Positive sharemarket trends face laws of gravity

A QUESTION a lot of investors have been asking in recent times is how strong is the uptrend in the US sharemarkets and will the Australian market match the performance of its US counterpart.

Despite all the talk of Australia having a miracle economy that escaped the worst of the global financial crisis, the All Ordinaries Index is down 12 per cent on the highs it reached a year ago and is only up 7 per cent on last December's nadir. On the other hand, the S&P 500, the broad US market index, rose 23 per cent since December to recent highs and is still up 19 per cent and has bettered last year's highs.

While some of the economic data coming out of the US points to recovery, Alan Clement, a member of the Australian Technical Analysts Association, says the outlook for the US sharemarket may not be good.

Clement comes to his conclusion by looking at both the price of the S&P 500 and its underlying volume trend. "It's one of the tenets of technical analysis," Clement says, "that for a trend to continue in a given direction, the volume of the instrument traded should trend in the same direction as the price."

If that's not the case, then the price trend will tend to run out of steam and a change of direction will ensue with the price falling towards the volume price trend (VPT). The VPT is worked out by multiplying the daily volume by the daily percentage change in price and plotting an index with that information.

The attached graph shows how accurate that tenet has been for the US market since 2010. During the second half of 2010, there was a strong upward trend on the S&P 500 that was backed by a rise in the VPT.

Then, in the first half of 2011, the market traded pretty much sideways in what some thought was a consolidation phase of the gains made the previous half. But a look at the volume side of the equation showed something disturbing. The VPT was trending lower, indicating sellers were winning out over buyers and enthusiasm for stocks was waning.

Pretty soon the "laws of gravity" according to technical analysis came to the fore and in August the market started to fall. A rout ensued and the US market bottomed in October as the panic about Europe spread.

The recent US rally pushed the S&P 500 above its 2011 highs. But the VPT has only managed a weak sideways pattern, barely breaking through the levels reached when the market bounced off its early October lows. This indicates the buying in this bull run has been lacklustre and will likely weaken the rally, Clement says.

Falls in the last week or so may indicate the first cracks are appearing. Unless there is an uptrend in volumes the market may give up recent games or simply consolidate.

The only drawback of using volume trend as a leading indicator, Clement says, is that it doesn't give any indication of when a change in trend might occur. It is still a useful warning signal, and a handy tool for the wise investor's armoury.

This column is not investment advice. Those wanting to invest should seek professional counsel.

rodmyr@gmail.com