Worries About Big Stock Selloff Keep Investors Out of Market

What if they planned a stock market correction and nobody came?

Inside the New York Stock Exchange.
Oliver Quillia for CNBC.com
Inside the New York Stock Exchange.

Although investors were widely expected to return after the Labor Day holiday, volume has remained surprisingly light. The reason: so many people are worried about a big selloff that they're staying out of stocks—at least for now. And that's kept the market relatively flat so far this month.

"Everyone is just kind of looking at the long end in general, hoping for a correction of some magnitude and it's not coming," says Michael Cohn, chief investment strategist at Atlantis Asset Management in New York. "So everyone is really just sitting on their hands and not doing anything to a great extent."

Annual volume on the New York Stock Exchange is running about 20 percent below the same period for 2008, according to data from Thomson Reuters. Average daily volume for September 2009 has been 1.44 billion, compared to 1.49 billion in 2008 and 1.57 billion in 2007. For chart and analysis, click here.

A run of warmer weather to start the month also may have prolonged vacations and tamped down interest, say experts. And Labor Day—often seen as a green light for market activity to resume after the summer—came later than usual.

Still, with September the worst month historically for stock market performance—and with the market either at or rapidly approaching overbought status—there's not as much reason this year for investors to flock back.

"Clients are calling me up and saying they want to get back in the market," Cohn says. "When I tell them I want to take it slow and see what happens, every single person says, 'I really love that idea because I hear that the market goes down this month.'"

So when will investors come back? Market pros think volume could pick up soon and add some volatility to a relatively moribund market. There already are signs that the slowdown in volume is changing.

Tuesday, which is the sixth trading day since the holiday, was shaping up as the fourth busiest in the past month. Traders saw the increase coming from investors who may have missed the summer rally and were trying to find an entry point.

The influx of more retail investors will be a stern test to see if the six-month stocks rally can hold up.

"Volume is so anemic," says Dave Rovelli, managing director of US equity trading at Canaccord Adams. "All these technical moves we're making, there's no stamp being put on them because there's no volume. The whole month of August was a drift higher on low volume, which does not tell you anything."

Increased volume often brings higher volatility, which in turn brings both opportunity and peril for investors who could get whiplashed if the market does correct.

"There's still a large amount of cash on the sidelines because people haven't believed this rally is for real," says Don Betrand, vice president of Wealth Trust-Arizona in Scottsdale. "Volume and volatility have been relatively low through much of the summer. If volume does pick up, I think that may mean volatility is going to pick up as well."

Rovelli agrees that the market is likely to get "much more volatile" as autumn progresses, and he believes investors need to be careful. He's calling the situation a stock-picker's market with some opportunities in technology and energy but danger elsewhere.

The Standard & Poor's 500 has already nearly completely priced in earnings projections for next year, he says.

That has some portfolio managers looking to protect cash even as market activity is likely to pick up and their clients get antsy to put money to work.

"Really it seems like to a certain extent if there's any hesitancy it's to be in cash," says Gary Flam, portfolio manager at Bel Air Investment Advisors in Los Angeles. "Now you're seeing good economic data. There's a hesitance to be in cash and people are looking for a pullback to get more invested. It seems to be the investor sentiment, though that's not exactly our sentiment."

Flam sees market turbulence not necessarily in the short term but probably over the next six months. The risk-reward scenario is not setting up well in the current market for those who who have a long-term outlook, he says.

The Chicago Board Options Exchange Volatility Index has been on a steady trek lower and is reaching the 20 mark, which indicates lower than normal volatility and indicates that, at least for the moment, investors are holding tight.

"If you've had a good year you don't want to screw it up," Cohn says. "So it's better to sit pat here."