August 23rd, 2010

Laws of Supply and Demand At Work In The Stock Market

A recurring theme over the past week has been the talk of the money flowing out of equities and into fixed income, like the following from Bloomberg:

“The amount of money flowing into bond funds is poised to exceed the cash that went into stock funds during the Internet bubble, stoking concern fixed-income markets are headed for a fall. Investors poured $480.2 billion into mutual funds that focus on debt in the two years ending June, compared with the $496.9 billion received by equity funds from 1999 to 2000….”

or

Stock funds have had $215.4 billion of outflows the two years ended June, ICI data show. Citigoup’s Tobias Levkovich says “The extremities of the money flows into fixed income from equities is troubling. In 2000 or late 1999, we saw massive amounts of money going into the equity market at just the wrong time. I feel the same way when I look at all the money going into bonds.”

Anyone who has taken Econ 101 understands the laws of supply and demand. We’ve see it at work in the fixed income market where the demand has pushed bond prices up and interest rates down to levels not seen in 60 years. But what’s going happening in the equity market? Shouldn’t we have suffered through an offsetting and equally large decline in equity prices due to the large volume of stock sales triggered by the mass exodus?

Actually, we haven’t and it’s perplexing. As frequently pointed out here, the market has been in an interminable horizontal trading range of 1025-1150 for about a year. Rather than correcting 20-25% to the 850-950 range after it’s dramatic run-up from the March 9 bottom, the market has remained relatively flat for some inexplicable reason.

Some take that as proof that the big drop is about to come but I understand it to mean that there’s been more than sufficient demand to absorb all those dumped shares. If I remember my economics correctly, price changes happen coincidentally with the trading volume, not as a result of that volume. Prices change to encourage and facilitate transactions not as a result of trading that took place sometime in the past.

I side with those who believe that some or all of the money that flowed into fixed income will, sometime in the near future, begin migrating back into equities. However, this time, those who absorbed those disposal sales by being on the buy side won’t be in such a rush to relinquish their shares. They’ll hold on and demand higher prices since there aren’t many attractive alternatives (as all those fixed income holders will soon find out).

That’s how supply and demand works. I’m not the one who’s bullish, it’s the market and it’s price action over the past year that is convincing me to be so.

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  • jojo

    August 23, 2010
    Hey Joe did you see the
    news at 3:30pm ?

  • Joe

    jojo, I was on my way to the airport so I didn't catch the news. Can you fill me in what your hinting at?

  • Jesse

    when the market gets down to 850-900 you will write a blog about how you saw this coming and you pointed out the possibility of this happening and so forth. But the truth is in the face of worsening economic data you have continued to stay very bullish. You made a statement at the end that said you're not the one that's bullish, the market is. Nothing about being flat over a year is bullish. The markets telling you it's been neutral after a massive rally from 666 and now is starting to roll over. The head & shoulders pattern is there in plain view. The moving averages are telling you what's about to happen, warning in spades. The hindenberg omen confirmed this week warning a crash is coming within 4 months or less. The 20 1week is now within 7 points of the 50 1 week and this weeks action may cause the cross. I love to read those who have the opposite view as me, but when you begin to deny & ignore 99 out of 100 points of data to support a bull case it's like watching Mike Tyson get embarrassed because he still thinks he's in his prime. Joe, the markets not bullish, you are. You're full of hope and optimism and those are good things. I think Americas best days can be in front of us, but a lot needs to change. excellent documentary film that spells it out well – http://www.youtube.com/watch?v=D22TlYA8F2E

  • Bala

    as a chartist I see the foll:
    (1) the bottom happened during July is weak, so nasdaq will break below that july bottom low of 2061

    (2) nasdaq formed a double top at 2307

    see my earlier comments

  • Anonymous

    joe, where are you going?? come to southwest? (remember you said your parent live in AZ)

  • Anonymous

    I am not selling my TNA that I Bought today @ 32… going to hold a little while…

  • Jesse

    Ben said the FED with save the US, so buy buy buy. 1.6% GDP is awesome! the economy is in recovery! lol
    just do what they tell you…

  • Bala

    Jesse

    I have done lot of research in intraday patterns, I'm looking for someone to share the work load, if you are interested please email me – balapandian@yahoo.com

    Bala