Is the Bull Run Pulling Up Lame?

--trading volumen has been trending dowarward from 7.2 bil shares in March to 5.14 bil shares now --the number of companies joining the gains have been shrinking Overextended Rally Seen Ripe for Downturn; Look Out 6547.05, Says Mr. Roth By E.S. BROWNING The stock market is stumbling. After a powerful rally that pushed the Dow Jones Industrial Average ahead by more than 30% in three months through last week, stocks are clearly having trouble extending their gains. Many analysts see a pullback ahead, and they are debating whether it will be just a temporary annoyance or something bigger and more painful. Indicators of market health, including trading volume, buying demand and trading by companies and corporate insiders, are beginning to flash yellow or red. People also are beginning to question whether the economic fundamentals are strong enough to justify continued gains. View Full Image Christopher Serra The Dow finished Friday at 8539.73, down 3% for the week. It is at the same levels now as in early May. The Standard & Poor's 500-stock index, which a week ago was up as much as 40% from its March low, ended Friday was at 921.23, still 36% above the low. "This 40% rally isn't based on a 40% increase in fundamentals," says Michael Farr, president of Washington, D.C., money-management firm Farr, Miller & Washington. "The economy is still declining. Credit isn't coming back. Unemployment is rising and we are seeing a much less robust consumer. I think the market at some point is going to give back a large portion of these gains." Mr. Farr and others say it is impossible to know whether the market already has topped out, or will edge higher before giving up the ghost. But even many bullish investors see a downturn ahead. Stocks have surged since early March in part because government stimulus spending has found its way into financial markets and because some investors have moved money out of cash and into stocks. Other investors may emerge from the sidelines. China Investment Corp., the giant sovereign-wealth fund, is considering potential U.S. investments. Its chairman, Lou Jiwei, has expressed concern that the fund is in danger of missing opportunities as the market rallies, according to people who work with the fund. While those forces could keep pushing stocks higher for a while, some investors and analysts see signs that the rally's underpinnings already are weakening. Stocks seem a lot less cheap than before their big gains, and investors are no longer impressed when the economic news is simply less bad than before, says Linda Duessel, market strategist at Federated Investors in Pittsburgh. She thinks improving corporate-profit reports will help push stocks significantly higher in the summer and fall. But, first, "history would suggest we would get a 5% to 10% correction somewhere," she says. That's the optimistic view. Pessimists think the damage could be greater, and the real pessimists worry that stocks could fall to new lows by autumn. They say stocks just aren't behaving as they have at the start of past bull markets. Consider trading volume. Average daily volume for all New York Stock Exchange stocks hit a record of 7.21 billion shares in March, as the rally began and heavy buying sent stocks sharply higher. That slipped to 6.42 billion in April, and so far this month, it is running at 5.14 billion, putting it well below the 2009 average of 6.15 billion a day. "A new bull market is one when investors are prepared to commit larger and larger amounts of new money to equities," says Paul Desmond, president of Lowry Research in North Palm Beach, Fla. "What we have seen here is a very consistent drop in total volume going back to early April." Mr. Desmond says his data, going back to the 1930s, don't show any new bull market with such a weak volume trend, which leads him to believe that this rally won't become a lasting bull market. Other data reinforce that concern. The number of stocks joining in the gains has begun to shrink, which doesn't typically happen this soon in a real bull market. And Mr. Desmond's measure of stock demand, based on the amount of trading volume and price change occurring on stock gains, indicates that demand has been fading, another negative signal. "Investors are risking smaller and smaller amounts of capital and that is a bad sign," Mr. Desmond says. Phil Roth of New York brokerage firm Miller Tabak shares many of these concerns, and has other worries as well. New stock issuance hit a record in May, he notes, which has created a lake of supply just as demand is softening. Senior corporate officers, who had been buying for their accounts earlier this year, have become net sellers. Neither trend supports the market. Mr. Roth says indexes still might gain some ground before topping out, and he wouldn't be surprised to see the Dow hit 9000. But once it starts to fall, he fears, it could sink below the March closing low of 6547.05. People who recently took money from cash and bought stocks won't want to reverse course unless they get a shock, he says. If they do get a shock, perhaps an indication that the economy's troubles are more lasting than people had hoped, that could produce new selling and new lows. "At some point, investors will be saying, where is the good news?" he says. Mr. Roth also tracks corporate-bond yields, because falling bond yields make bonds less desirable and can help stocks. While Treasury bond yields overall have been rising this year, the difference, or spread, between corporate yields and Treasurys has been shrinking. The spread between yields of double-A corporate bonds and Treasury bonds has averaged 1.45 percentage points over the past 30 years, Mr. Roth says. At its worst during the credit crunch last year it was 3.81 points. Recently, it has fallen to 2.78 points, better but still not half way back to average. That means corporate bonds remain more attractive than normal and are competing with stocks for investor money, especially when investors are nervous. Given the big recent stock gains, investors seem to be waiting for either a fall in price or a considerable brightening in the economic outlook before they put a lot more money into the market. "We could see a little bit more upside and then some very frustrating, choppy trading in the summer, setting up for a traditional October low," warns John Schlitz, chief technical strategist at Instinet in New York. Write to E.S. Browning at jim.browning@wsj.com