Thursday, March 08, 2007

Where's The Flow? XLB: The Materials Stock ETF

A little while back I looked at the 30 Dow Jones Industrial stocks and asked the WTF question: Where's The Flow? What I found was that, even after the large market drop, the Relative Dollar Volume Flows into the Dow stocks were subnormal. Based on earlier research, this suggested that we had further to go on the downside before investors decided we had reached prices that represent irresistible values. Most recently, I came to a similar conclusion re: the S&P 500 Index stocks.

As I noted recently in the Trader Performance section of my personal site, I've begun to assemble Relative Dollar Volume Flow data on a sector-by-sector basis. Above, we can see the stock price of XLB, the sector Spyder for the materials stocks vs. the ten-day Adjusted Relative Dollar Volume Flow for five of the major stocks held by the XLB ETF: DD, DOW, AA, IP, and WY.

I refer to this as the *Adjusted* Flow because we're looking at the difference between the Relative Dollar Volume Flow of the five stocks and the 200 day average. The pink line in the chart above represents a simple 10-day moving average of adjusted flow. The horizontal red line at zero indicates the level at which that Relative Flow equals the 200 day moving average. Thus, when we see positive Flow numbers, it means that we have above average dollars flowing into the five stocks; when we have negative numbers, it means that below average funds are moving into those issues.

Several patterns are worthy of mention. First, as bull swings age, we tend to see waning dollar volume flows into the stocks. The XLB peaks around March, 2005 and May, 2006, for example, were preceded by lower highs in the Adjusted Flows. Similarly, the recent sharp peak in XLB was preceded by a lower high in Adjusted Flow.

We can also see from the chart that periods of negative Adjusted Flow have represented good buying opportunities in XLB. As noted in the earlier article, we can tell that XLB has bottomed once we notice above average flows returning to the component stocks. This movement from negative to positive Adjusted Flow has been a great buying signal that seems to capture the shift of supply and demand within the sector.

Finally, note that, despite the recent sharp market drop, we have not seen outright negative Adjusted Flow among the materials stocks. A careful look at the daily data finds that flows turned outright negative on February 27, 28, and March 1st, but then returned to above average thereafter. In other words, investors appear to be using the weakness to put more money to work in this sector. This tells us something important both about the sentiment within the materials sector, but also about the sentiment of stock investors overall. Beneath the market surface, there may be sophisticated large participants picking up relative bargains in specific sectors.